If you are risk-averse, consider investing in fixed income securities. Fixed income securities offer guaranteed returns. You enjoy returns in the form of fixed periodic payments and get the principal at maturity. Fixed income securities are an excellent investment for retirement.
After demonetization, banks cut savings bank interest rates and FD rates. Investors rushed to mutual funds with record investments via SIPs. Now, as the rupee depreciates against the Dollar (1 Dollar = Rs 73) and petrol prices in Maharashtra head above Rs 90 a litre, inflation must be controlled.
The RBI in its last two policy review meets has gone for back-to-back repo rate hikes. The repo rate has gone up from 6% to 6.5%. There are chances of a further rate hike in the month of October. The Government has increased small saving schemes interest rates and banks are offering higher rates on FDs. As mutual funds bleed, investors are rushing back to their beloved fixed income securities.
So what are fixed income securities? Let’s find out. Want to know more on Corporate FD? We at IndianMoney.com will make it easy for you. Just give us a missed call on 022 6181 6111 to explore our unique Free Advisory Service. IndianMoney.com is not a seller of any financial products. We only provide FREE financial advice/education to ensure that you are not misguided while buying any kind of financial products.
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Fixed income securities offer periodic income payments at interest or a dividend rate which is known in advance. The most common fixed income securities include treasury bonds, corporate bonds, CDs (Certificates of deposit) and preferred stock. Returns are on a fixed schedule, but amounts could vary.
Company fixed deposits:
Company FDs offer higher interest than bank FDs, but are slightly riskier. Invest in Company FDs with the AAA rating which may offer 1% higher returns than bank FDs. Lower rated Company FDs may offer even higher returns, but you must exercise caution.
These are similar to SIPs in mutual funds. You invest small amounts regularly (once each month) for a fixed duration. Interest is similar to bank FDs. You get a lump sum at maturity along with accumulated interest. Senior citizens get higher interest. Banks offer 6-7% interest on RDs.
Liquid funds are a type of mutual funds which invest mainly in money market instruments like certificates of deposits (CDs), treasury bills, commercial paper and reverse repo.
Fixed Maturity Plans:
Fixed maturity plans popularly called FMPs are closed-ended mutual funds with fixed maturity and invest pre-dominantly in debt. You can invest in FMP only during the days open for subscription via NFO.
FMPs invest in certificates of deposits, corporate bonds, commercial paper and other money market instruments. The fund manager invests money in financial instruments of similar maturity. If your FMP has a maturity of 4 years, then the fund manager invests money in corporate bonds of maturity 4 years. FMPs follow the buy and hold strategy. There is no frequent buying and selling, keeping expense ratio low.
Returns on FMP: The returns from the FMP are indicative yields. Returns offered are indicative, but not assured. Returns could be higher or lower than indicated in the NFO.
Taxation on FMP: FMPs are an excellent investment if you fall in the higher tax brackets vis-à-vis FDs. Capital gains on FMPs if held for less than 3 years are called short-term capital gains (STCG). These gains are added to taxable salary and taxed as per tax brackets. Capital gains on FMPs if held for more than 3 years are called long-term capital gains (LTCG). LTCG enjoys the indexation benefit. (Returns are adjusted for inflation and this means lower taxation).
Debt mutual funds:
Debt mutual funds invest in short term and long term bonds across maturities. They invest in money market instruments like certificates of deposits (CDs), commercial paper (CP) and treasury bills. A debt fund portfolio invests in bonds of varying maturity.
Take a look at the modified duration which is the measure of price sensitivity of the debt portfolio vis-à-vis interest rates. If interest rates go up or down by 0.5% in a particular month, the NAV will go up or down by 2%, if the modified duration is 4 years. Yield to maturity (YTM) is what a bond earns from coupon/interest payments and also annualized gains/loss on purchase price if held till maturity.
How to choose debt funds?
You are in a rising interest rate scenario. This is when bond prices fall as interest rises. You will find bond NAVs falling. In periods of high interest, its best to avoid long duration bonds which are highly sensitive to rate movements and prices crash. It’s best to opt for short term funds in rising interest rate scenario like FMPs and liquid funds.
Credit risk: If the Company financials are not sound, they could default and investors lose principal. IL&FS a reputed Company in financial services, defaulted on bank loan interest payments and also term and short-term deposits. It also defaulted on commercial paper obligations.
Interest rate risk: When interest rates rise, prices of long duration bonds fall. New securities are available at higher prices and offer a higher yield. Investors lose interest in the older securities. Invest in short term debt during rising interest rate scenarios.
Reinvestment risk: This happens when the security you invested can’t fetch the same returns at maturity or at the time of reinvestment. This happens in a falling interest rate regime.
Price risk: A number of fixed income securities are listed on stock exchanges. Many investors might want to exit fixed income securities before maturity. The prices of fixed income securities are impacted by interest rate movement and volumes of trading. You might exit the investment in periods of low liquidity and not get the right price for it.
Purchasing power risk: If the returns from fixed income securities are not able to beat inflation, this is purchasing power risk. You have to consider returns after taxation and these returns must beat inflation.
PPF is an excellent fixed income investment which currently offers returns of 8% effective October 1st 2018 and returns are not taxed. It offers inflation beating returns.
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