The conservative investors with low risk appetite are facing the risk of erosion in the purchasing power of their capital invested in Fixed Deposit (FD) in banks or in similar fixed income instruments as the interest rates on such instruments lag behind the rate of inflation.
Even if the interest on such instruments matches the rate of inflation, it ultimately fails to beat the price rise after paying taxes on interests earned.
The Biggest Risk
Already facing the certain risk of capital erosion, taking no risk will be the biggest risk for the FD investors, who don’t have abundant money to withstand the devaluation.
Need of Diversification
So, to keep the purchasing power of their capital intact, conservative investors have no choice but to diversify.
How to Diversify
While diversifying, apart from some high yield fixed return instruments, the investors should also consider allocation of some part of capital in equity and gold.
Hedge with Gold
As gold acts as a hedge during the falling economy and market cycle with higher return, it will help in reducing the volatility. That is in case of market fall, the rising gold prices would do a balancing act and vice versa.
Even in case of investments in fixed income and equity, instead of putting money in single bond or stock, further diversification may be done by investing in mutual fund (MF) schemes, i.e. Debt Funds and Equity Funds respectively.
Mutual Fund Investment: Should you do asset allocation yourself or opt for hybrid funds?
To get a return similar to the return of the underlying benchmark index, an Exchange Traded Fund (ETF) – that replicates the composition of the index in its portfolio – may also be considered.
In case an investor finds it difficult to invest in Debt Funds and Equity Funds separately, he/she may choose a Balanced Fund.
Similarly, instead of investing in physical gold, investors may choose Gold Funds or Gold ETF for safety and liquidity.
For convenience in investments, investors may choose Multi-Asset Funds, that, apart from investing in debt instruments, equities and gold would also put some money in international stocks for geographical diversification.
So, investors may either choose to do asset allocations themselves or may choose tailor made funds, but they have to diversify and can’t simply stick to FDs to stay ahead of inflation.