Tuesday, May 7, 2013

Do I Need Debt Instruments in my Portfolio?

In the past couple of articles, we took a look at the Debt Markets in India as well as the different types of Debt Instruments that are available for us to invest in. However, the biggest question we all will have right now is "Do I Need Debt Instruments in my portfolio?"

The purpose of this article is to, try to answer this question...

If I were to answer this question in one word, the answer would be - YES.

Yes, we need Debt Instruments in our portfolio. The reasons are as follows:

1. Portfolio Diversification

Portfolio Diversification is a term used by investment experts to suggest that we must invest in different types of instruments and should not stick to just one asset class. By investing in various asset classes like Equities, Gold, Debt, Real Estate etc., we can cushion our portfolio against adverse effects of downfall in any of the aforementioned categories. For ex: If all your investments are in the Stock Market and the market takes a plunge, what would happen? You will end up losing a lot of money. Whereas, if you had diversified your portfolio and included other asset classes like Debt, Gold etc., your losses could've been minimized...

2. Capital Preservation

One of the main reasons why people especially elders prefer Debt Instruments is "Capital Preservation". The profits I make out of my investments may be low, but my principal amount invested will never be in question. In case of other asset classes like Gold or Equities or Real Estate, there is a chance that the value of my asset goes down below the price I paid for it. In case of Debt Instruments, that will never happen. So, owning a certain portion of your assets in debt instruments shields your capital from the volatility of the other asset classes.

3. Generate Regular Income

Debt Instruments are excellent at capital preservation. They are also very good at generating regular income. A big portion of the senior citizen population in this country depend on Interest Income for their sustenance. Usually when people retire, they get a lump sum amount from EPF, Gratuity etc. They usually deposit that money in a bank fixed deposit in monthly or quarterly interest paying options and then use the interest income for their sustenance. A few months ago, there was an article titled "Have You Thought About or Planned for Income After Retirement?" where I had shared some ideas to generate regular income after retirement. Debt instruments were the top 3 suggestions in that article.

4. Liquidity

Yet another strong point for Debt Instruments is their liquidity. Debt Instruments are highly liquid. Based on the timeframe for your investment you can choose the type of debt instrument that suits your needs perfectly. Durations as low as a few days to as long as 10 years or more are available. In almost all cases, options of premature withdrawal too exist which makes them the best asset class in terms of Liquidity.

Liquidity is a term used to signify, how easy it is to sell an asset and convert it to cash.

As you can see, Debt Instruments have their strong points which suggest that, even the Most Aggressive type of investor must have around 20-25% of his/her investments in Debt Instruments.

On the flip side, Debt Instruments do not give the extravagant rate of returns like Equities which makes them less favorable. However, I personally feel that everyone must have a healthy exposure to debt instruments for the four reasons mentioned above...

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