Debt investments – why, where and how

I have been away to my home town for for 2 weeks on and managed to club my daughter’s convocation as well as a trip to Ajodhya hills in Purulia during this time. Was not able to write my blog in this period and saw that quite a few readers had put their queries on Debt investments. So in this first post after the break, let me try to address this issue in a comprehensive manner.

To begin with, do you need debt at all? If the annualised returns from equity investments are in the range of 12 % and more and you are struggling to get even 7-8 % in Debt investments, then why do you really need to invest in it? Well, the most important reason is that your investment growth with equity normally follows a rather tortuous path. Think of a situation where all your money is in equity and there is a market crash, which reduces your portfolio value by 30-40 % and it takes a long time to recover. In this period you may well have goals coming up such as children’s education etc which cannot be postponed. In such a scenario you will be forced to sell your equity investments at the wrong time. Not only will this have a significant negative impact on the growth but there is also a serious opportunity cost involved. Let me try to explain this with an example :-

  • Let us assume I was preparing for my son’s admission into a B school in 2019 and was planning for a portfolio of 22 lacs for the same. I had been doing SIP into 2-3 MF schemes for a long time to achieve this.
  • Due to the upsurge in our markets in Jan 2018, the portfolio value had already reached 21 lacs and I was sure that the portfolio will be well above this figure in 2019 March, when I need the money.
  • Unfortunately, the market corrected a fair amount already and let me assume that it will correct to -30 % till March 2009. 
  • My portfolio value will suddenly be 15 lacs only and I need 7 lacs from elsewhere.
  • I have 100 lacs in my retirement portfolio and was hoping it will increase to 200 lacs in 6 years @ 12 % annual returns. Wanted to retire in 2024.
  • Due to the market downturn, my portfolio for retirement became only 70 lacs by March 2019. On top of it, I also had to take 7 lacs out of it. My retirement portfolio then reduces to only 63 lacs in March 2019.
  • Even with a 12 % return now I will never get back to 200 lacs or anywhere close in my retirement – in fact I will have only about 120 lacs.

In case you are thinking that such things cannot happen, let me tell you from personal experience that such occurrences may well happen for 3-4 times in a 30 year period for which many of us normally invest. I myself have gone through 3 such experiences in 2001, 2008 and 2011 which created quite some difficulty for my plans. Fortunately, my asset allocation had the cushion of debt investments and I also did not need the money for any of my goals.

Well, I hope it is now clear as to why you need Debt investments as part of your portfolio. The issue now is where do you invest it and how. As I have covered it in other posts of my blog, I am only presenting the solution here, rather than giving a full explanation.

  • For all salaried people, PF is a must and you need to make sure that you do not withdraw from it. Keep it only for your retirement.
  • For all others a PPF account is a must. In fact, I will say the salaried people should have one too and others can have one for their spouse as well.
  • If you have a daughter then you can go for SSY as well.
  • Retired people or ones looking at regular income can look at Tax Free Bonds and Senior Citizen’s Savings Scheme along with Vaya Vandana Yojana.
  • Others can look at short term debt funds and also Hybrid type funds such as MIP and Equity Savings Funds.
  • Finally, you can look at long term Gilt funds if your time horizon is really long.

What about the asset allocation? Well, if you are working with an active income you can keep Debt to Equity at 35:65. For people in the FI state it can be 45:55, for retired people 55:45 and for senior citizens above 70 it should be 70:30. Remember that you will definitely need both equity and debt at all stages of your life, unless you have way more assets than you will ever need.

Whichever way you look at it, Debt investments are critical to your financial well being.

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At current market levels Asset allocation is an imperative

One of the main reasons stock market and other bubbles get created is that we all love good times and good stories. It gives us an emotional kick to see that a stock that we hold has gone up by 10 % in a couple of trading sessions and the MF portfolio we hold has been clocking impressive gains over the last few months. In our heart of hearts and also in our rational minds we do know that the party will end, sooner rather than later, but it is far more exciting to believe that it somehow will not.

We all understand asset allocation at a fundamental level so I am not going into details. However, in simple terms for most portfolios of investors, the following need to be kept in mind when we are looking at asset allocation:-

  • Assuming you have 2 main asset classes Debt and Equity, decide on an asset allocation for yourself. 
  • In my view you must have at least 35% in Debt. This is fairly easy once you take your PF account money into consideration.
  • Periodically review to see if the allocation has got skewed by more than 5 %. In such cases sell from the higher asset and buy into the lower one.
  • For example, right now due to the run up in the markets your equity allocation may be 72% and debt 28 %. Sell off some equity and put it into a debt product such as Liquid fund etc. This provides your partial hedge against a market downturn.
  • What to sell? Again, look at stocks or MF which have run up the most and use your judgement as to which looks like the best bet.

What is my take on the current situation? I feel that there is a little more steam left in the markets yet, the Nifty may well reach 10800 levels by end of this month. However, beyond that or even before there is every likelihood of a correction to 9500 levels and below.I do not believe that we will really see a crash in the Indian markets in the near future.

Based on the above premise take a serious look at your asset allocation this week and next. It is tough to sell something which is doing so well but you are really protecting some gains and limiting your future losses by doing so. Many people may tell you that you should simply hold and that the gains will again come back in the future. However, that is speculative and asset allocation is a way better strategy which is also a proven one.

I am sure you have never done it in the case of your MF portfolio built up through SIP – one more reason why the way SIP is done and administered, leaves a real lot to be desired.

The reality of any bull market is that there will be intermediate cuts – some not so deep and the others fairly deep. At such points you have opportunity to add more to your portfolio in a productive manner, as long as you have cash to do so. Being conscious of asset allocation and having a strategy for the same allows you to do just that.

In current markets you must follow asset allocation

One of the main reasons stock market and other bubbles get created is that we all love good times and good stories. It gives us an emotional kick to see that a stock that we hold has gone up by 10 % in a couple of trading sessions and the MF portfolio we hold has been clocking impressive gains over the last few months. In our heart of hearts and also in our rational minds we do know that the party will end, sooner rather than later, but it is far more exciting to believe that it somehow will not.

We all understand asset allocation at a fundamental level so I am not going into details. However, in simple terms for most portfolios of investors, the following need to be kept in mind when we are looking at asset allocation:-

  • Assuming you have 2 main asset classes Debt and Equity, decide on an asset allocation for yourself. 
  • In my view you must have at least 35% in Debt. This is fairly easy once you take your PF account money into consideration.
  • Periodically review to see if the allocation has got skewed by more than 5 %. In such cases sell from the higher asset and buy into the lower one.
  • For example, right now due to the run up in the markets your equity allocation may be 72% and debt 28 %. Sell off some equity and put it into a debt product such as Liquid fund etc. This provides your partial hedge against a market downturn.
  • What to sell? Again, look at stocks or MF which have run up the most and use your judgement as to which looks like the best bet.

What is my take on the current situation? I feel that there is a little more steam left in the markets yet, the Nifty may well reach 10300 levels by next month. However, beyond that there is every likelihood of a correction to 9500 levels and below.I do not believe that we will really see a crash in the Indian markets in the near future.

Based on the above premise take a serious look at your asset allocation this week and next. It is tough to sell something which is doing so well but you are really protecting some gains and limiting your future losses by doing so. Many people may tell you that you should simply hold and that the gains will again come back in the future. However, that is speculative and asset allocation is a way better strategy which is also a proven one.

I am sure you have never done it in the case of your MF portfolio built up through SIP – one more reason why the way SIP is done and administered, leaves a real lot to be desired.

My cash flows and investments in April

April has been a good month for our markets with all the major indices hitting a lifetime high. My Stock and MF portfolio have done rather well and while I am not one to keep looking at my net worth every day, it does feel good to see it grow well in this month. For all people with an asset allocation strategy in place, this will be a good time to shift some money to debt. However, the question is which debt instruments will really work out in the current situation, where the interest rates are probably bottoming out?

I think it will be a good idea to outline my own situation in terms of the cash flows in April and how I have invested them in the month. These situations and decisions are unique to me but it can be definitely useful learning to some of the readers. Let me start with the cash inflow first. The month of April had significant cash inflows for me from the sources given below:-

  • My active Management consultancy income from the software company where I work currently as Chief Strategy Officer.
  • Some consultancy income from a couple of holistic life plans I have made for 2 people who had reached out to me.
  • Rent from my Chennai apartment which largely goes into paying for our current apartment in Hyderabad.
  • Interest income from tax free bonds
  • Dividend income from stocks in my portfolio
  • Dividend income from some MF schemes in my portfolio
  • Redemption proceeds of some FMP schemes on their maturity

My regular expenses that require cash outflow are as follows:-

  • Household expenses including rent for our apartment.
  • Amount sent to my parents every month for supplementing their income.
  • Expenses incurred on my children, separate from their college fees.
  • Any discretionary expenses including travel, entertainment and gifts.
  • Contribution to 2 charities of our choice.

As of now my passive income is enough to meet the above expenses in an ongoing manner and therefore my active income is almost totally invested. Besides for the FMP redemption proceeds, I invest the principal and use the capital gains as part of passive income. In April, the FMP redemption principal was to the tune of 11 lacs and this needed me to decide where should I put it back.

The investments I have done in April are as follows:-

  • PPF contribution to the maximum for my wife and me.
  • FMP plans from Reliance, Sundaram and BSL.
  • MIP from BSL
  • ICICI Value Fund series 12
  • Sundaram Micro cap fund series 11

Why have I invested in the following and will I be doing the same in May? The answer to the second part is no, as I look into each month separately now, keeping the overall asset allocation in mind. 

The first part has a more complex answer and I will try to provide it in the next post.

 

 

Asset allocation is an imperative now

One of the main reasons stock market and other bubbles get created is that we all love good times and good stories. It gives us an emotional kick to see that a stock that we hold has gone up by 10 % in a couple of trading sessions and the MF portfolio we hold has been clocking impressive gains over the last few months. In our heart of hearts and also in our rational minds we do know that the party will end, sooner rather than later, but it is far more exciting to believe that it somehow will not.

We all understand asset allocation at a fundamental level so I am not going into details. However, in simple terms for most portfolios of investors, the following need to be kept in mind when we are looking at asset allocation:-

  • Assuming you have 2 main asset classes Debt and Equity, decide on an asset allocation for yourself. 
  • In my view you must have at least 35% in Debt. This is fairly easy once you take your PF account money into consideration.
  • Periodically review to see if the allocation has got skewed by more than 5 %. In such cases sell from the higher asset and buy into the lower one.
  • For example, right now due to the run up in the markets your equity allocation may be 72% and debt 28 %. Sell off some equity and put it into a debt product such as Liquid fund etc. This provides your partial hedge against a market downturn.
  • What to sell? Again, look at stocks or MF which have run up the most and use your judgement as to which looks like the best bet.

What is my take on the current situation? I feel that there is a little more steam left in the markets yet, the Nifty may well reach 9000 levels by next month. However, beyond that there is every likelihood of a correction to 8500 levels and below.I do not believe that we will really see a crash in the Indian markets in the near future.

Based on the above premise take a serious look at your asset allocation this week and next. It is tough to sell something which is doing so well but you are really protecting some gains and limiting your future losses by doing so. Many people may tell you that you should simply hold and that the gains will again come back in the future. However, that is speculative and asset allocation is a way better strategy which is also a proven one.

I am sure you have never done it in the case of your MF portfolio built up through SIP – one more reason why the way SIP is done and administered, leaves a real lot to be desired.

Current markets – Impact on your goals and wealth

As the market situation continues to tumble from bad to worse, many investors who were confident of the long term market story are also getting the jitters. While I do think that personally the current fall is not much of an issue as I do not need to take money out of equity for the next 10 years, I can well understand that it may not be the case for many others. Over a small period of 1 month there has been a serious destruction of wealth for many retail investors and it may indeed take a long time for them to recover it.

Why is the situation different for retail investors today, when such ups and downs have always been part of the markets? Over the last few years the market returns have been good and this made the long term returns look rather optimistic. Many people who started investing in MF though the SIP route, were sucked into believing that a double digit market return over the long run was a given and even 15 % returns over a long term is quite possible. A lot of financial planning for important goals in life were done on this basis and is therefore now a problem in most cases.

Let us look at the Sensex returns over the different time periods till August 27th 2015. This data is from HDFC MF site and the returns if anything are actually much poorer now after the carnage of last week. All returns are in percentages.

  • 15 year return on the Sensex is 12.61.
  • 10 year return on the Sensex is 13.07.
  • 7 year return on the Sensex is 9.06.
  • 5 year return on the Sensex is 7.82.

If you had put your money in an ultra conservative debt product like the PPF, you would have done better in 7 years. However, it does not really work that way as you put money over a period of time and not just one time. To understand the real impact of the market fall, look at the reduction in your portfolio value for the equity portion. For me the reduction has been to the tune of 15 % and I do have a considerable equity portfolio, so even in absolute terms the drop is huge. I had suffered a similar experience in 2008, only the size of my portfolio was much smaller then. I would imagine that for most people investing through SIP in the last 7-10 years, the drop in portfolio value would be between 12 and 18 %.

Is this a passing phase? In other words, will the wealth that you have seemingly lost today come back? Yes, it will as the markets will recover over a period of time, the key question being when. However, this takes a serious toll on your portfolio as the growth goals you had assumed in your financial planning may undergo a serious change now. The extent of the impact is based on how long do you have till your goals and what types of goals these are. While, it will be difficult to address all possible situations, I will try to give some pointers to different categories of people.

If your goals are still a fair distance away, say at least 7 years or more you need to try the following:-

  1. Rejig your financial plan if you had taken 15 % or greater CAGR for equity growth. I would go fairly conservative and 12 % will be the maximum figure.
  2. Check your asset allocation now. For people with significant goals coming up in the next decade make sure that you have at least 40 % in Debt instruments.
  3. Your financial plan must be such that your goals can be met through debt instruments if that becomes necessary.
  4. Look at the possibility of targeted one time investments in MF, based on market situations. SIP does not really work well in a secular bull market and some of the current portfolio losses are a proof of that.

On the other hand if your goals are in the next couple of years, here is what you should be doing:-

  1. In case your goal was financial independence or early retirement, accept the fact that It will probably take more time than what you thought. Continue the current activities you are engaged in for earning active income till you reach a point where such a goal can be actualized.
  2. If your goal is mainly consumption oriented, that is you want to purchase an asset like a car/home or go on a vacation etc. you need to consider postponing the goal. Do not try to get this done by taking more loans than what you can afford, this will reduce your investment capability in a market where you do need to invest.
  3. For other goals that cannot be postponed, such as child’s college admission etc try to mobilize money from your debt portfolio to meet the current required cash flows. In case you cannot do that consider taking an Education loan with the understanding that you will pay it back quickly.
  4. If you do not have a significant debt portfolio start building it by transferring money from sources other than equity to this – for example if any insurance or ULIP policy is maturing then put the proceeds in some debt fund.

In general, the only immunity that you can have in a falling market is your ability of not needing money from your equity portfolio till the time the markets have had a sufficient chance to recover.I have no idea of how much time this will take but in my portfolio I can even wait for 10-15 years if need be, before I touch it for redemption.

I am happy to see many people have got started out here. Also, become a part of my Facebook group Market Musings where a lot more is discussed on the general market situation and also individual stocks.

Interested readers may pls follow my blog on email by clicking on the relevant button on the right hand panel. I will shortly be stopping the practice of posting the links in different Facebook groups. Following the blog will ensure you get intimated whenever there is a new post.

How I plan to invest for now

In the last post I had written about the generic guidelines that one could follow in the current market situation. As is well known, every investment situation is different and the plans for investment will need to cater to this. I thought it will be a good idea to share my own investment plan with readers to give them a real life example on how you can make changes to your investments.

To give a brief background of my current situation for those who do not have an idea yet, I am now running a Consultancy practice in Hyderabad for IT and ITES organizations after having had different corporate roles in the Software space for 27 years, the last 15 years of which were as CEO. Right now I am financially independent as I have a passive income stream that meets my expenses. All of my active income is therefore available for investment purposes, indulgences and charitable causes. If you are interested in knowing more about my investment portfolio, search the blog for relevant posts.

Coming back to how I want to change my investments :-

  • Right now a part of my passive income comes from dividends in Stocks and MF. Though I do not anticipate a major downward revision in this amount, it is possible that the MF dividends will get lower for next FY if the markets continue their downward trend.
  • Fortunately, my passive income has the cushion of about 20 – 30 %, so even with a reduced dividend amount I should still be able to get along quite well. Moreover, some LIC policy maturing in December of this year can be used if needed. As such, there is no real risk to my FI status due to the markets tanking.
  • I currently have SIP in 7 funds that I will reduce to 5. Also, I plan to stop the SIP mode of investment as I believe the markets will go through frequent gyrations before resuming the uptrend sometime in 2016. I therefore want to invest more in my MF now, through tactical one time investments based on the market movements.
  • My plan here is to use my FMP maturity amounts to buy equity for now. This will be both for one time purchase of MF as well as bolstering my stock portfolio for making selective purchases.
  • Once the markets resume their upside trend, I will put money into debt funds to balance out the asset allocation.
  • My plan is to buy stocks which are already part of my portfolio through price triggers. I anticipate there will be several buying opportunities between now and December.
  • My equity portfolio remains for the long term, I do not need to touch it for the next 10 years.

If I look at my net worth it has depleted significantly over the last 2 weeks. However, the losses are notional and as I do not have any plans to redeem from either my stock portfolio or my MF portfolio in the short or medium term, I am quite hopeful of the net worth improving tangibly over the next few years. My expectation is that the Indian economy will do well over a period of time and earning of companies will improve, thereby pushing up stock prices and market indices.

The current market situation is therefore a definite opportunity, though one with fairly painful side effects !!

I am happy to see many people have got started out here. Also, become a part of my Facebook group Market Musings where a lot more is discussed on the general market situation and also individual stocks.

Interested readers may pls follow my blog on email by clicking on the relevant button on the right hand panel. I will shortly be stopping the practice of posting the links in different Facebook groups. Following the blog will ensure you get intimated whenever there is a new post.