To tide over tough times, investors must set aside a fixed income corpus with tax free bonds and high quality debt instruments
With the stock markets volatile, gold prices at a six-year high and banks reducing interest rates on deposits, investors will have a tough time managing their investment portfolio. Falling interest rates will prevent investors of fixed coupon payments from earning the same rate of returns after maturity. Also, incremental returns over Nifty and Sensex have been gradually coming down, which will make investment in equities tricky. Given the economic slowdown and host of other domestic factors affecting the equity and bond markets, here are four factors that an investor must keep in mind for long-term investment.
Have a long-term investment horizon
Investors who understand the power of compounding end up making money over a period of time. Very importantly, tax efficiency kicks in when invested for the long term. If you look at performance of equity and bond markets over long periods, risk of capital reduces significantly. Even in volatile times, retail investors must continue to invest through systematic investment plans.
Watch Video: How To File ITR-1 for AY 2019-20 in less than 15 minutes
In a falling interest rate regime, fixed-income investors should invest in equity through the systematic investment plan (SIP) of mutual funds. SIPs allow an investor to buy units on a given date each month. The biggest advantage of an SIP is that the investor does not have to time the market.
Understand your risk tolerance
An investor must be clear about his short- and long-term goals which will give him direction and keep him focused. Investors must understand that higher risk does not translate into higher returns. Most investors in equity look for high returns and try to time the markets. So, in the process of trying to earn higher returns, they invest in unknown small and mid-cap companies, or IPOs of companies without a strong balance sheet. In volatile market conditions, such investments often turn red. For higher long-term returns, balance risks with returns.
Choose debt funds of different maturities
To tide over tough times, you must set aside a fixed income corpus with tax-free bonds and high quality debt instruments. If you have surplus liquidity for six to nine months and are willing to take marginal risk to earn higher returns, you can invest in short-term funds. Alternatively, to reduce the reinvestment risk because of falling interest rates on fixed deposits, investors can put money in long-term debt instruments and lock into the current interest rates.
They can also look at small savings schemes like 5-year National Savings Certificates which currently carries a 7.9% interest rate; post office 5-year monthly income scheme (7.6%); 9.4-year Kisan Vikas Patra (7.6%) or simply a 5-year post office fixed deposit to earn 7.7%. The next reset of small savings rate will take place in September-end, which will be applicable for three months October to December.
Investors can also look at tax-free bonds of state-owned companies such as IRFC, PFC, NHAI, HUDCO, REC, NTPC, NHPC from the secondary market. Unlike corporate bonds, these bonds are safe and are attractive as the investors will not have to pay any tax on the returns. While the interest payments on these bonds are free of tax, there would be capital gains tax if an investor sells before maturity at a profit.
Keep portfolio simple
Keeping your portfolio simple will make it extremely efficient and powerful in the long run. Moreover, an investor must understand when to exit if there is under-performance or an unforeseen requirement. As choosing the right investment vehicles are critical, you must have a portfolio with a mix of high quality mutual funds with proven track record, listed stocks if you have a penchant and tax-free bonds that will take you through market optimisms and declines.
To meet cash flow needs, look at liquidity and protection of capital. If you forsee a liquidity requirement, the redemption amount should not erode the original capital invested. Track the performance of your investment every year and rebalance the portfolio if required.