It is that time of the year when investments such as Fixed Maturity Plans, mostly invested by you for double indexation tax benefits, mature and swell your bank balance. Are you allowing this money to lie in your account even if you have no near-term requirements for it? Here are the risks you run:
- It simply vanishes as it is spent in no time.
- If you decide to wait for an opportune time to invest, you miss out on returns while your money earns just 4% in your savings account.
- Given that interest rates show all signs of having peaked, you may end up settling for lower returns later.
So what should you do with the investment maturity?
You have a few choices. One, invest in a bank fixed deposit. Yes, while the returns at about 9% may seem reasonable, the post-tax returns at under 6.5% (30% tax bracket) hardly provide you with inflation-beating returns.
Two, you could once again look up for FMPs with similar maturities and reinvest. You can consider doing this if your requirement is as follows:
- You don’t need any liquidity and are okay locking in the money at this stage.
- If you actually have a financial requirement coming up in the next 1-2 years. In that case, you can choose an FMP that fits the time frame of your goal and reinvest.
Ensure that the FMP’s scheme information document states that the money will either be invested in certificates of deposits or commercial papers; else in top-rated bonds.
The flip side of investing in an FMP without a time bound goal for your money is that you may end up with reinvestment risk, i.e., the risk of being in a low interest regime when you get the money after maturity a year or two later.
Hence, if you do not have any goal and may actually need liquidity at some point, then you will be better off going for open-ended debt funds. In this category, you will benefit from the following:
- Capital gains indexation benefit similar to FMP, if held for over 1 year.
- High liquidity with option to exit any time.
- Benefit from interest accrual on the underlying instruments as well as capital appreciation when rates fall.
But the choice of debt funds would depend on your time frame. We suggest the following funds for a 1-2 year time frame and also for a 2-plus year holding period.
Short Term Debt Funds (1-2 Year Time Frame)
This category is suitable if you are not sure when you will need your money, but can hold for not less than a year. You will mostly find funds loaded with certificates of deposits and commercial papers in this category. Such funds also account for a majority of our ‘Select Funds’ in this bucket.
But we would like to slightly tweak our approach to focus a bit more on funds that invest in corporate bonds as opposed to primarily CDs and CPs. While a portfolio with CPs and CDs will certainly hold a lower risk profile, we think the recent dip in yields in this category has already provided some returns.
HDFC Short Term Opportunities and Templeton India Short Term Income Plan are our picks in this space. Both the funds have higher exposure to corporate CDs with the HDFC fund sporting more AAA-rated bonds while the Templeton fund has higher weight to AA-rated bonds. The yield to maturity and average maturity of the Templeton fund is higher and therefore its risk profile is a notch higher.
Income/accrual funds (over two-year time frame)
Birla Sun Life Short Term and Templeton India Income Builder Account are the two funds of our choice in this category. Why these two funds? Because they keep their duration reasonably consistent and also avoid higher portfolio maturities. Besides, they follow an accrual approach with a good chunk in corporate bonds.
Of the two, Birla Sun Life Short Term Plan has higher exposure to AAA-rated securities, while Templeton Income Income Builder has more weight for AA-rated corporate bonds such as Power Finance Corporation, L&T Finance and other popular corporate houses. These funds can benefit from any rate cut and ensuing price rally as well.
You do not need to stagger your investments in the above debt funds. Lump sum investments are fine, especially given the prevailing rate scenario. Reinvest you money now to avoid opportunity loss and also gain tax benefits.