Should I Go For Fixed Income Products

It's said that 'Investing money is not an easy task', one wrong step and your entire investment vanishes into thin air in no time. So what does a wise investor do? He also parks some part of his money in debt or fixed income products. The hallmark of fixed income investments is that they are relatively safe and generate a fixed or known rate of return. In addition, they present a number of options to match one's needs.

Nilima, 42, has garnered savings of around Rs 45 lakh – about Rs 25 lakh in equities and remaining Rs 20 lakh in fixed income areas. Now, she wants to focus on fixed income investments as she considers they will be the mainstay for her future, providing her the required regular flow of income.

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Analysis

The role of fixed income instruments is important in everyone's investment portfolio.

Reasons:

1. They help build a secure future by providing a regular flow of income along with a low or zero volatility.
2. Some of them are also high on safety.

What are the options for Nilima?

Nilima has plenty of choice, with an array of instruments ranging from fixed deposits to company deposits and from nonconvertible debentures to post office instruments. However, whether she achieves her investment objective will depend on how and what investment mix she chooses.

Here we discuss the factors Nilima should take into account before finalising her fixed income instruments.

A) Safety

The most important aspect of fixed income investments is safety. These investments need a lower risk as they represent an entirely different asset class.

In Nilima's case, already more than half of her savings or Rs 25 lakh are exposed to a high risk since they are in equities. Thus the remaining amount has to be safe from erosion in value.

Let's see how different fixed income investments cover this point:

Fixed deposits: An FD with a public sector bank will have a very low credit risk compared to other banks as a public sector bank has government backing and will not be allowed to fail in any circumstances.

Company deposits: They provide higher return but there is a higher credit risk also. This could result in a sudden stop in payments of interest and even the capital can be at risk if the position of the company deteriorates.

Debentures: They offer a regular return, and are present in two forms: secured and unsecured. The latter is more risky as there is no security behind the debentures and in case of a poor financial situation of the company the investor could find it difficult to recover his/her investments.

Nilima's investments

Nilima would want that a specific proportion of her fixed income investments, say around 60 per cent, is in safe areas. This means she would require Rs 12 lakh to be channelled to such instruments.

B) Liquidity

The prime reason to invest in an instrument is to earn returns, but there is also the question of liquidity. Liquidity means that in case some of the invested money is required for emergency or other use then this can be withdrawn through the presence of an exit route. Nilima has to anticipate this to fix how much money she should have in liquid instruments.

Disadvantage: There will be lower return in this case.

1. A fixed deposit can be withdrawn after payment of a penalty in terms of the interest earned.
2. Other instruments like long-term bonds will not allow exit except at specific time intervals, but they are likely to have a higher return.

C) Time Period

Like in any other investment, time period is also a vital aspect of fixed income instruments. Often there are higher rates of return available for a short duration of time.

Nilima's investments

1. Long-term instrumentsNilima plans to use the funds for her retirement corpus, hence she needs some long-term instruments that have a higher rate of return.
2. Short-term instruments
   Short term instruments will require constant watch in order to look for new opportunities as the older instruments mature.
3. Specific requirements
   Nilima also wants a regular income of Rs 1.5 lakh from the investments plus a sum of Rs 4 lakh after 5 and Rs 6 lakh after 10 years in case there is a shortage of funds for specific requirements in the house.

In the search for such a choice some amount of returns might have to be compromised. There should also be a mixture of investments across different types to avoid the concentration of risk in a certain area. This would also help Nilima get different rates of return on the instruments.