Last post I briefed about all the asset classes that are available for investing. Starting this post I will cover each asset class in detail. This should help in deciding one's mix of investing.
So first lets start with our most familiar asset class : Debt
What are they?
The term Debt refers to a sum of money which is owed or due. So Debt is any sum of money which is loaned by one entity or individual to an entity. The entity which owes the money, gives the loanee interest at a fixed rate (referred as Coupon rate) and returns the capital sum at the end of a fixed tenure called as maturity. The frequency of payment of interest can be monthly, quarterly, half annually or annual.
What are the available options?
Banks FDs and RDs
The holy cow of common investor because of its simplicity and association with the banks. Which gives a sense of security to most of the people. It does offer fixed returns over a given tenure and offers low risk. But one must take into consideration the inflation rate when calculating returns on FD/RD.
Public Provident Fund/Provident Fund
Almost every Salaried man’s retirement planning instrument. One contribute to PF from every months salary and an equal contribution is made from the employer. The good rate of interest and tax free maturity amount makes PF and PPF popular. However they have long lock-in periods, 15 years for PPF and PF matures at the age of 58 of contributor or when contributor stops working.
Corporate FDs
Companies need capital to run business and the source of lending for them are banks. But because of various guidelines by central bank, often banks alone cannot fulfil the capital requirement of the companies. So RBI allows companies to collect money form common investor in the same way as banks by offering fixed deposits. These have fixed rate of interest and tenure. They may have option to earn cumulative interest. As this is issues by companies which deal with greater risk and uncertain conditions running their business, corporate FDs are riskier than those offered by banks. But as the risk is higher, so is the rate of interest.
Bonds
A Bond is a debt investment which is issued by an entity for a defined period at variable or fixed interest rate. The borrower thus loans money to the issuer and owns their debt. Typically companies, municipalities, state or central governments raise money by way of Bonds to fund their new projects, expansion plans or spend on infrastructure. The issuer issues a bond which contractually states the rate of interest called as coupon rate and time period of return of principal amount called maturity date. Additionally Bonds also state the coupon date which are dates on which bond issues will make interest payment which can be semi-annually or annually. Bonds are fixed-income security. Some Bonds are traded on exchanges while others are traded only over the counter.
Debt Mutual Funds
The term Mutual Fund is a fund collected from investors with mutual interest. The Debt mutual funds are type of mutual funds which make their investment in mostly debt instruments. These can include all of the above debt instruments. To give better spread and gain better returns, some debt mutual funds will invest part money in equities.
What are advantages and disadvantages of investing in Debt?
Debt investment are good because they offer
- highest liquidity
- low risk
- guaranteed returns
- returns at fixed tenures
- are good for fulfilling short term requirements
However they are
- not inflation proof
- low returns
- long lock-in periods in case of PPF, PF and some bank FDs
- not suitable for long term wealth creation
- not tax efficient as only interest upto Rs. 10000 gets tax rebate
How much returns I can expect?
The returns vary for different Debt instruments. The rate of interest for Debt is governed by a number of parameters like SBI fiscal policy, Repo and Reverse Repo rates and long term government bonds with tenure of over 30 years.
Currently bank FDs are typically offering 6-8% returns while their corporate counterparts return 8-11%. Rate of interest for PF is 8.65% for FY 17-18 and that for PPF is 7.9%. Indian economy currently is going through a falling interest regime.
Myths
Bank FD are secure as they are guaranteed by government
Almost everybody believes its the safest investment option which does not have any risk. People believe even if bank defaults, RBI/Government will return their money back. Government returning money, really?. Think again. The FDs and RDs are backed by insurance. However there is cap on the amount which is covered. Currently this cap is Rs. One Lakh only. So no matter how big is sum of your FD, in case of bank goes bankrupt, you will get back Rs 1 Lakh for sure.
