You can use debt investments to beat inflation and provide relative stability to a portfolio
Wealth creation happens over the long term and it should not be at the cost of giving up the current lifestyle. One needs to invest in such a manner that the overall return on investment is higher than the rate of inflation. Only then can we see wealth creation. Or else, inflation would erode away your wealth.
One basic rule of wealth creation is investing across different asset classes, what is called asset allocation. However different assets have different levels of risks, and one can address these risks by investing over different investment horizons. Higher the risk associated with an asset class, higher is the return potential. Just because one is young doesn’t mean one can alone take a higher allocation in risky asset like equities. What if the young person had to buy a house, in say the next 2-3 years? A large portion of investment into equities at that time may put him at risk. Therefore, investment horizon is key while deciding asset allocation.
Different assets that one considers for wealth creation could mainly be divided into equities, debt, real estate and gold. The least amongst these in terms of risk is debt, followed by gold, real estate and then equities.
The one asset class that investors in India are absolutely comfortable with is debt. I think that this is the only asset class where the investor himself/herself picks and invests in; while, for every other asset class you tend to look for an intermediary who would often persuade and push you into investing.
Debt as an asset class tends to be amongst the safest investment avenues available to retail investor; and hence offers lower returns than the other asset classes.
There are different types of debt mutual funds depending on the investment horizon and risk level. There are those, where one can invest for a short duration of say one day. Then there are those where one can invest up to 1 year. Typically, for investors with an investment horizon of more than a year, long-dated debt schemes are recommended.
The allocation to the debt asset is dependent on many factors, but most important of them is the risk-return profile and the investment horizon of the investor. An investor can use debt mutual funds to beat inflation-led erosion of assets. Debt investments are also used to provide relative stability to a portfolio.
This stability factor is one of the reasons why the ratio of allocation in debt assets tends to increase with the age of a person. This is because, as a person grows old, the individual’s ability to take risk on investments for higher returns begins to diminish. At the same time, the need for regular income on investments also tends to increase as one grows old. These requirements have a corresponding match with the core features of debt assets and tend to be suitable for the investor profile in such an age group.
In a market environment, wherein the key policy rates are expected to decline, the long-term performance outlook in debt remains largely bullish. However, the uncertainty of the market timing, may lead to some volatility from time to time.
Consequently, we advise investors to allocate their debt corpus to various maturity profiles, depending on the risk-return appetite and the investment horizon. However, in the given context, if an investor has more than one-year investment horizon, he/she may invest in long duration funds to position their investments for potential capital gain opportunities.
To sum up, successful investing requires will to save a substantial sum; a long-term investment plan; the diligence to stick to, and modulate the plan according to times; to invest across the asset classes; and to utilize professional and competent portfolio management services (largely resolved through mutual funds). Therefore, it helps to reassert that a disciplined and systematic approach to investment will go a long way in fulfilling the aspirations of life.