T H E R I G H T M I X Risk and returns need to be balanced

Fixed income products like FDs, RDs and bonds are products which retail investors swear by. As planners, we have these as part of the portfolio as these offer fixed returns and hence lend stability to a portfolio. It gives that assurance of a certain accumulation at the end of the investment period, which is important for highpriority goals that cannot be compromised. Goals like retirement funding and children's education fall under this category.      However, as planners, we would need to consider several aspects before suggesting products from the fixed income space. We would need to consider volatility, risk, uncertainty, taxation, time horizon and liquidity.      Income from FDs, bonds and RDs are added to one's income and taxed. This makes the post-tax return much smaller than what is apparent at first.      For someone in the highest tax bracket, the post-tax returns from an FD offering 9% would be just 6.2%. Since inflation is much higher than this, the money actually 'degrows'. However, some of these products are kept in the portfolio for the lower risks they carry.      In case of bank FDs of up to Rs 1 lakh, there is depositinsurance protection and hence safe. It also has liquidity, which helps in case of an emergency. It can be broken and used up. A somewhat better alternative would be sweep-in deposits, where above a particular amount in the savings account, the money will be swept into an FD. A much better way of handling liquidity would be through investments in ultra short-term funds. Currently, these funds offer good returns of over 9%. Better still, if invested in the dividend mode, the tax incidence is only 13.5%. That means the posttax returns using this product is much higher than for a product like FD.      Products like FMP and PPF, though good, do not offer liquidity and must be considered if the investor has the time horizon, which matches the tenure of the product or the liquidity window provided in the product.      We also need to consider risks inherent in a product. A lower rated NCD, for instance, would offer better returns, but comes with higher risk. Always, the risk and returns need to be balanced in a portfolio. Higher risk may be assumed for higher returns in some measure, if the client is young and the goals are not very near. Also, the client has to have the stomach for higher risks. Else, the client will be highly uncomfortable throughout. The correct balance of risk and return needs to be struck in the portfolio.      Also, there would be a lot of people who cannot assume higher risks, like retired people, for whom capital protection is important. The planner should take this into account while constructing the portfolio.      Debt funds offer a tremendous tool for getting excellent returns at low risks. Also, there are debt funds across tenures and across the risk spectrum, which allows us to choose the right product that would be suitable in a portfolio. We consider debt funds for their tax efficiency.      In all debt funds, longterm capital gains (after one year) are taxed at 10% without indexation and 20% with indexation. In simple terms, the tax will be in single digits instead of being 20% or 30%. This helps in pushing up the returns of the portfolio without significantly adding to the risks.      Debt funds however don't offer one fixed return, which is a sore point with investors. Also the returns can fluctuate, which will cause apoplexy in many.      Fixed income instruments are vital in a portfolio. The allocation in the early stages should be somewhat low as the emphasis would be on growing the corpus. Over time, the amount in debt instruments will need to go up. There is no single formula for arriving at how much fixed income portfolio one should have. How much it should be, depends on the client's needs. It is our job to judge that to a nicety, and offer good tax-adjusted returns.      The author is founder, Ladder7 Financial Advisories