Debt investments which have worked well for me lately

As many of my readers will know well by now, I am a great advocate of the 3 portfolio strategy with Debt, Stocks and MF each having an important place. Of these, stocks and MF are typically for the long term and something I will normally not redeem in the next decade at least and maybe even later. Debt is different – in my FI state I depend on it for passive income and use some of this for my regular expenditure. 

One of the obvious approaches in debt investments is to understand the interest rate cycle and try to lock investments for a possible longer term, in order to maximise your interest earning out of these. While there is a bit of luck and speculation involved in this, if you are following the economy properly, it is possible to get these signals correct more often than not. A few of the situations in the past years which has really stood me in good stead are as follows:-

  • I normally put some amount as FD for my parents so that they get a monthly amount to supplement their income. I consolidated a larger amount in 2015 and locked it in for 3 years at a rate of 9.5 %. Current rates are 7.5 % only.
  • Despite several people advising me against it, I went ahead and invested in a big manner in the Tax free bonds of 2013-2014. The rates were close to 9 % and today it gives me an interest to meet nearly 25 % of my annual expenditure needs.
  • Our earlier POMIS matured in December 2015 with a rate of 8 %. I reinvested 9 lacs in a joint account with my wife at a rate of 8.4 %. Today the rate is 7.5 % or so.
  • In the 2013-2015 period I rolled over most of my FMP schemes as the rates of interest were favourable and it made sense to lock these in further. 
  • I also invested fresh into many FMP schemes as it seemed a good idea to have investments which locked into government papers at the then prevailing rates.
  • I continued my investments in PPF even though the rates kept coming down based on the alignment of Small savings schemes to the market rates. The EEE nature of it plus the possibility of a rate increase when the cycle reverses make it worthwhile.

While all of these were great till 2015 or so, since the last year, with the rates going down steadily with each RBI policy, Debt instruments have become more of a challenge. For all the instruments that are maturing today, one needs to look into alternatives that will give decent returns compared to a pure debt product.

In the meantime however, I am quite happy with the above decisions I had made. The best of them were definitely the investment in Tax free bonds.

FMP redemption – a case study in April

As all my regular readers will know, a lot of my debt investment have been historically into FMP instruments. The basic premise of this is simple – it is a safe investment with relatively stable interest rates you can lock into for 3 years or more, the indexation benefits are good and consequently the taxes are reasonably low. If you want to read more about why I invest in it you can go through the FMP related blog posts.

The way I approach FMP redemption proceeds can be summarised as below:-

  • The capital gains are used for my regular expenditure if required. These form a good part of my passive income stream and, more often than not, I use it for some discretionary expenses.
  • I normally reinvest the principal amount in some other debt instrument, it could be FMP again or something else depending on the context of time.

So far in April, 3 of my FMP investments have been redeemed and the overall details are as follows:-

  • The principal amount in these three were 7 lacs.
  • Total capital gains arising out of these redemption is 2.25 lacs. In terms of XIRR it translates to around 9.75 % which is pretty good.
  • At this point in time, I do not really need the capital gains for my expenditure. This is mainly due to my active income through Consultancy which is more than adequate to take care of my regular and discretionary expenses.

Based on the above considerations I have decided to invest 9 lacs out of the redemption amount. In the present interest rate cycle, investing in pure debt products will really not make sense. As such, I am looking at the following distribution:-

  • Dual advantage FMP which invest in equity to a small extent.
  • Close ended equity funds such as Sundaram long term micro cap fund.
  • Equity savings funds.
  • MIPs
  • Funds such as ICICI Balanced Advantage fund or Edelweiss Absolute Return fund.

As some of these funds are dependent on market levels, I will be waiting for the annual results to be out. My feeling is Nifty will get down to below 9000 levels shortly and that will be a good time for me to buy these instruments.

 

How should you invest in Debt instruments now

While the current economic and business scenario is rather worrying for most investors, there are also opportunities that present themselves in the current context. If you look at your Debt allocation now, you may be worried about what you should be doing about the low returns that are already there and will possibly get far worse. 

Let us see what is likely to happen in the different types of debt instruments, based on the current situation and what you can do about it:-

  • There will be a secular reduction in interest rates and we will probably get back to the 2004-2005 situation. The one difference from there will be that the rates may not rise again the way it did at that time.
  • Assuming the rates are going to be staying here or get lower in the near future, it makes a great deal of sense to lock in investments now. Look at the ubiquitous FD, Post office MIS or Dynamic Bond funds.
  • Capital protection plans will be a good idea now, look at available schemes from good fund houses and select ones with 3-5 years duration.
  • FMP investment may also be a good idea but make sure you do it in the next month or so and be clear about the return expectations.
  • If you are looking at Debt MF, try the Duration funds with a time frame of 3-5 years. At this point of time, do not go for funds with longer duration.
  • In the present context a return of 7 % or anything more will be quite good if you are going for pure debt.
  • Rates in PPF and SSY will reduce but these are long term instruments and therefore investors should continue with them.

Given that a fair amount of my portfolio is in Debt, what are my plans for it? Let me first say that in 2016 at least, the performance of Debt has actually been better than equity. Here is what I have and how I plan to deal with it:-

  • Tax free bonds give me an interest of 8.9 % now. Even though I am having handsome capital gains from it, I plan not to sell them and keep getting the interest.
  • PPF accounts for me and my wife – I plan to continue both and invest the maximum permitted in 2017 also.
  • My FMP plans have given me pretty good returns, in several cases over 10 %. The ones getting redeemed will need to be deployed elsewhere.
  • As of now regular FMP does not make much sense – I plan to go for Dual Advantage funds, Short duration Debt funds, Balanced funds or MIP.
  • In general, it will be a good idea to invest in instruments which are hybrid in nature and not just pure debt in the next one year.

How you deal with your money is something you have to decide – make sure you understand the entire landscape, listen to sensible advice and take the right decisions.

Small savings rates and market alignment

In the budget this year, one of the significant announcements was that the small savings rates in the various schemes will be aligned to the market rates. From an economic viewpoint this is unexceptional – after all it does not make much sense for the government to pay you more than what the market is offering you on similar instruments, often coupled with a higher level of risk.

However, i was somewhat skeptical with this announcement as similar attempts have been made before and not much had come out of it. In case you follow the annual chaos that often accompanies the fixing of PF rates every year, you will probably get what I am trying to say here. The basic issue is this – there is a very strong constituency which invests in these products and it is not easy to disregard them for any government. Over the years dependence on these products have reduced to some extent, thus making is possible to reduce the rates significantly over time. Nevertheless, it will be quite another matter to make the rates completely market linked without raising a lot of hue and cry.

In the actual event the rates were changed for the first quarter, left untouched for the second quarter and have only been marginally tinkered with in this quarter. So the PPF rates are still 8 % and the SSY rates are at 8.5 %. If you look at these rates being market linked as per the declared policy then we are about 50 basis points higher today. The chances are that the rates will hold for the current FY and further reductions will happen in the April 2017 quarter.

What does this really mean for your investments in schemes such as PPF and SSY? Consider the following :-

  • These are part of your debt allocation, so cut out the noise and do not try to compare it ever to equity returns.
  • Understand that though the rates will probably not be completely market linked, over the next 2 years or so they are very likely to go down further.
  • I feel that PPF rates can go down to 7 % in the next year or so. The SSY rates will generally be 50 basis points higher than the PPF rates.
  • 7 % tax free returns on your money is still worth quite a lot. At the highest tax bracket you will need to earn more than 10 % from an instrument whose returns are taxed, in order to match this. There are simply no such instruments.
  • If you are not needing income out of your investments, just keeping them where they are makes a great deal of sense.

Remember, these are long term products and will also get benefited by the interest rate cycle. Over the next 5 years or so interest rates will rise again and all your investments earning a tax free return will be a bonanza then. Furthermore in a low inflation regime any real rate of return that is guaranteed along with tax breaks will always make eminent sense. Debt has a specific place in your portfolio, understand and act accordingly.

What are my plans on these schemes? Well, I have a long running PPF account and my wife has restarted her account 3 years back. Till the rates are at 7.5 % levels I plan to keep contributing regularly to it. At the current rates today, we earn sufficiently from it to cover about 50 % of our annual expenses. Assuming we keep investing 3 lacs in it for the next 7 years or so, the income generated from these accounts will probably cover our entire annual expenses at that time.

The only caveat to this is any possible changes in the tax treatment of these schemes. I do not think that is likely, given the difficulties that the government is facing in aligning the rates to the m

My Debt portfolio – using PPF

With the rate reduction in PPF scheme and the knowledge that it is likely to be aligned to market rates every quarter from now on, is it still a good idea to have it in my portfolio? In my audit of investments for this FY that was the main question I was faced with regarding my PPF investments.

Now in terms of personal finance every issue and decision is contextual and the situation of the individual makes all the difference. In my case I have a PPF account since 1994 and my wife has started a second account in 2013 after the first one was matured in 2004. Some details of these accounts are as follows:-

  • My present maturity is in 2019 April and current balance is about 20 % of our total debt portfolio.
  • My wife’s account will mature in 2028 and currently is about 3.5 % of our debt portfolio.
  • Contribution of 1.5 lacs is made every year in the first week of April to both accounts.

Given the tax treatment of PPF at EEE, I see no reason to stop my investments in it even though the interest rates have reduced to 8.1% currently. I think the returns on PPF will go down further to about 7.5% or so, but even that is not a bad rate for an EEE instrument. In the coming years the interest rate cycle is very likely to turn around and at that point in time, PPF will immediately get benefited as the rates are market linked now.

With the investment decision taken, the next issue is how to use the money in the account. So far I have not withdrawn any money out of my account since 1994 and do not plan to do so till the current maturity in April 2019. The same goes for my wife’s account. Her first PPF maturity amount had helped us greatly to boost the down payment that we were able to make for our apartment in Chennai.

So after a lot of thought these are the conclusions I have come to:-

  • Continue my account after 2019 for another 5 years while being open to withdrawals for any emergency post 2019.
  • Assuming that my daughter gets married in the period beyond 2019, such withdrawals can fund her marriage expenses to the extent needed. Even though I have investments in equity for it, a hedge against market crashes is prudent.
  • Withdrawals can also be used for discretionary purposes such as replacement of white goods, vacations outside India etc.
  • As I will normally not need the PPF account withdrawals for my regular expenditure at least till 2024 or so, in the absence of any of the above the money will simply grow.
  • As far as my wife’s PPF account goes it will grow to 40 lacs plus by 2028. At this point if the returns are decent we will continue it. Note that we can withdraw 24 lacs in the subsequent 5 years from her account.
  • Assuming that I can withdraw about twice that amount from my account in 5 years, the total withdrawn amount in 5 years will be 72 lacs. This can be used for a variety of purposes as explained earlier.

How will I fund the 3 lacs per year? As of now, I am doing it from my Consultancy income and hope to do so for the next 6-8 years. Beyond that or in case the income is insufficient in a year, I have plans to fund it through the redemption of debt funds such as FMP etc that keep happening every year.

In the end what does the PPF investment mean to me? Well, it is something from which I can withdraw any time I have an exceptional expense whether due to an emergency or due to an indulgence that we need to do. It also gives me the cushion of not having to redeem my equity investments for fulfilling a goal, when the markets are in a bad situation.

In short it contributes a great deal to my peace of mind.

My Debt portfolio – rethinking FMP

Readers who have read my earlier blogs will have a good idea about my 3 portfolio strategy and how I use it for generating passive income as well as growth for the future. A major part of my Debt portfolio is FMP schemes and I have been investing in these for the past few years to build up a decent portfolio.

In essence the FMP strategy was quite simple to start with, especially when the LTCG indexation benefits were available after 1 year. Between 2008 and 2013 the cost inflation index was increasing by more than 9 % or so every year. This meant that you could practically get tax free returns of 8 % or slightly more every year. All you had to do was reinvest the principal amount in another FMP scheme and use the capital gain for whatever purpose you wanted. When I was looking at setting up a passive income stream from 2015, this seemed like an ideal avenue. I reasoned, if I could have about 50 lacs in different FMP schemes and roll them over every year then my capital gains would be about 4 lacs assuming an return rate of 8 %. Along with some other passive income elements, this would go a long way to meeting the 8 lacs of current annual expenses that I have.

However, in the personal finance space any plan is good only in the current context and a change in the environment will necessarily mean you have to change your plans. The first spanner in the works were thrown by Arun Jaitley after BJP came to power. He made all Debt funds, including FMP, eligible for LTCG only after 3 years. This immediately meant that my plan of rolling over the FMP schemes yearly, was a non starter. Fortunately, some of the schemes I had invested in were already 3 years and for the rest a rollover was made possible by all the fund houses. As I was able to direct some of my active income towards my expenditure needs in 2015, the 3 year time frame did not really affect me. From 2016, I roughly have 20 lacs worth of FMP investment maturing every year. This will yield roughly 4.8 lacs in Capital gains as the holding period is at least 3 years for all maturing schemes. So in theory my earlier plan or reinvesting would still work, though with a 3 year duration as opposed to the 1 year duration I had thought of earlier. Note that I prefer FMP as the interest rates are locked in to a significant extent and are not prone to risks as other types of debt MF schemes are. For my debt portfolio, stability and regularity of returns is key.

Though the above strategy looked great, I am now having to rethink it as there is another significant change that has happened in our environment. With the inflation rates coming down, the cost inflation index will obviously increase at a lower rate as compared to before. In the last year the increase has been less than 6 % and going forward I do not expect it to be very different, a lower rate of increase is actually likely. This will mean that even after indexation, there will be some capital gains tax which needs to be paid. This is a double whammy for FMP schemes – the returns will get lower with declining interest rates and the effective taxation will come into play. The returns therefore seen unexciting now.

Now in 2016 I will have about 20 lacs of FMP maturing and I need to reinvest it somewhere. There are a few options that I have thought of. Pure debt funds will suffer from the same issues as FMP and they are likely to have higher credit risk too. Moreover the 3 year locking period with lower indexation benefits, suddenly make these funds rather unattractive. Even though I have never been a fan of mixing equity and debt, as they are very different asset classes, this may be a situation where such a course of action is pragmatic. The following options can be looked at:-

  • A conservative Balanced fund where the risks are contained.
  • An Equity savings fund with both hedged and non-hedged equity in addition to debt.
  • An arbitrage fund with mainly hedged equity.

The good thing about all of these is that LTCG becomes effective post 1 year. The risk is that if the markets do badly the returns from such funds can well be lower than the ones I am getting from my current FMP schemes. However, given the current situation, these seem to be a good idea as the credit risk is limited and potential of returns optimistic if the markets do well in the next 2-3 years.

Of course, once the interest rate cycle reverses the situation will become quite different and a return to FMP type of schemes may well be the order of the day.

 

 

Revisiting my Debt portfolio

This week I decided to do an overall audit of my Debt portfolio. The review was necessitated mainly by the changes in the Small Savings Schemes rates which were brought about. However, it is generally a good idea to do an audit in the beginning of a Financial year to see if any changes are required in the current plan.

As many of the regular readers will know, I have 3 portfolios namely Debt, MF and stocks. In my current state of Financial Independence, the debt portfolio plays a very important role. My main objective here is to get enough regular income out of this so that I do not have to depend on my active income through Consulting for my day to day expenses. As I have no real fresh investments planned for the Debt part, the only other objective is capital appreciation. So, if my Debt portfolio shows some appreciation after the withdrawals I make from it I will be happy enough.

In this post, I am not getting into the rationale of my current investments for the portfolio. Interested readers will need to go through my blog to search for the relevant posts. The audit only looks at what I have and what changes I plan to make.

  • Tax free bonds are about 12.5 % of my debt portfolio. These are bonds from 2013 and carry a coupon rate of 8.8 %. There is no real need to change this and it remains a good part of my interest income in the years to come.
  • PPF forms about 20 % of my debt portfolio. The reduction in rates to 8.1% means that I will now earn significantly less out of this. This will not impact my usage of money as I was not planning to withdraw in the near future. My plan is to keep investing for now and take a call in 2019 when the account reaches the current maturity date.
  • FMP schemes form about 45 % of my debt portfolio. The plan was to use the capital gains from here as my regular use and reinvest the principal. I plan to keep doing the same though the reinvestment will not make sense in FMP now.
  • Other Debt funds form about 12.5 % of my portfolio and the issues here are similar to FMP, as outlined above.
  • POMIS and some FD form the last 10 % of the portfolio and this will be unchanged.

The good thing is my income from Debt portfolio would not have been compromised a great deal. While PPF interest will be lower, FMP and POMIS rates are pretty much locked in and will therefore not reduce in any significant manner. Going forward, the real issue I will have to decide on is how do I redeploy my principal amount redeemed through the FMP maturity. The options I have thought of are Ultra short term funds, Balanced MF, Arbitrage funds and Equity Savings Funds. Each of these have their pros and cons and I need to look at what strategy will involve the minimum risk.

Of course, with the rates likely to decline further over the next couple of years, somer other strategies will probably be needed in my next annual review.