The investment in Debt products has become tricky since the IL&FS crisis but the closure of six funds from Franklin has shaken the investors. The investors have largely considered Deb Mutual Funds as a safe investment that would return alpha (1% – 2% extra return) over the Bank Fixed Deposits but never bothered about the risk associated with the return. But post the Franklin crisis, the investors are looking at return and risk in the same breath.
This is the time to revisit various debt investment options available with us and readjust our plan. I am putting the list of commonly available short term debt investment options and their nuances.
Banks Savings Account – Keep money in Savings Account to manage your short term cash flow needs. The interest rate of the Savings Account will be low and will change. The return may not beat inflation. If this is your primary bank for all your cash flow needs, stay with the large banks to avoid any disruption in the service. You can use a Mod / Sweep Account to earn a little extra interest if the money will stay in the account for up to a year. If you want to invest money for a longer duration, consider Recurring deposits and Fixed deposits.
Post office small Savings Scheme – Post office offers products similar to those offered by Bank e.g. Savings, Recurring Deposit and Term Deposit. Post Office offers a Monthly Income Scheme (MIS) for monthly payout. National Savings Certificate (NSC) and Kisan Vikas Patra (KVP) deposits can be considered for longer-term investment. The Interest rate is better than that of the bank. The investment is Sovereign guaranteed. Operating it may not be as easy as dealing with the banks.
Government Bonds – The Tax-free bonds are offered by government-owned entities (e.g. PFC, NHAI, HUDCO) with the interest rate in the range of 4% to 6% and are suitable for people in the high tax bracket. These bonds if not available in the primary market can be purchased from the secondary market. The GOI Taxable Savings bond is currently offering 7.75% interest and is suitable for people in the lower tax bracket.
Company Fixed Deposits – You can expect a higher return compared to the Bank Fixed deposits but invest only in AAA rated offerings to reduce chances of default. If you are considering Fixed Deposits from Housing Finance companies, stick only with the companies with strong financials.
Non-Convertible Debentures (NCD) – Opt only for secured debenture option of AAA rated offering from strong companies.
Mutual Funds – Overnight and Liquid Funds are the safest option as the maturity period is for a shorter duration i.e. up to 3 months but the return is lower. Investment in Banking and PSU debt funds can be considered only if the underlying asset quality is good. Investment in funds with a longer maturity (e.g. ultra-short, short term, medium, long term) have both credit and interest rate risks and should be considered only if one has a higher risk appetite. Arbitrage Funds while has equity taxation and can be considered as a proxy to the investment in Savings Account. The fund leverages mispricing in the market and takes a covered position to reduce risk.
Depending on the risk profile of a person, a combination of these investment options can be considered. People with lower risk profile should consider a combination of Savings Account, Overnight/Liquid Funds, Post Office Schemes and Government bonds. People with a higher risk appetite can, in addition, consider Company Fixed Deposits, NCDs and Debt Mutual Funds with longer duration. It is important that based on one’s risk profile, a proper allocation is done among various debt investment options to get the optimized return at an acceptable risk.
You may also like to read Should the debt mutual funds be part of your portfolio?
The writer is a SEBI Registered Adviser and Founder of FinMyn (https://finmyn.com). He provides Fee-Only Financial Planning and Investment Advisory services. If you want to know more about him, click on https://finmyn.com/about/.