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Don't Forget Debt Funds

The heady excitement of the action on the stock markets has made many of us forget all about fixed income investing. But don't ignore this vital component of your portfolio just because it lacks the excitement of the stock markets

Over the last three years, the heady excitement of the action on the stock markets has made many of us forget all about fixed income investing. Bank fixed deposits, RBI bonds, post office schemes, fixed income mutual funds and other such savings instruments still exist, but you can hardly detect their existence from the financial media and from the advice given by financial consultants. This silence on fixed income savings is not unjustified-the audience is just not interested, and I have first-hand proof of it. On ValueResearchOnline.com, fixed income funds make up 60 per cent of the 855 funds we cover, but they account for an abysmal eight per cent of the pages that are viewed by visitors on the site.

The cause of this inattention is obvious. Fixed income investments are perceived to earn tiny amounts of money compared to equity investments. While this is sort of true, it is unwise to form such impressions when the stock markets are at a peak. It's easy to see that in a year when the Sensex rises by 60 or 70 per cent, the six to eight per cent earned by a fixed income instrument feels like a joke.

However, there have been plenty of times in recent years when the shoe has been on the other foot. For example, the five year period from 1998 to 2002 saw the Sensex rise wildly and then fall to almost the same level. During these five years, being invested in the Sensex would have seen your money stagnate, while an 11 or 12 per cent deposit (which was the rate then) would have seen your money go up by about 75 per cent.

There's nothing that guarantees that this can't happen again. In fact, right now the stock markets are in an uncertain phase and many problems are looming large. With oil prices rising and the Middle East becoming even more unstable, rising interest rates clearly indicate that the time to pay attention to fixed income assets is here.

I'm not saying that one must sell every stock and put everything in fixed income, but having a certain percentage of your investment allocated for fixed income and more importantly, maintaining that percentage is something that every investor must do. Maintaining this percentage automatically means that when stocks rise more than the fixed income part does, one should sell some stocks and invest the proceeds into fixed income. This is a great way of ensuring that you keep booking some profits and taking them out into a lower risk investment.

Do note that not all fixed income investments are lower risk, at least in the short-term. Fixed-income mutual funds, in particular, those that invest in medium and long-term debt exhibit decidedly unfixed returns. When interest rates rise, these funds perform poorly and when rates fall, they perform well. This is unrelated to what the rate actually is, it is the change in rates that creates anomalous returns. I've oversimplified a little here, but the point is that for investors seeking lower risk, bank and government deposits and short-term mutual funds are the way to go.

Still, fixed income investing is hugely simpler than equity investments and there aren't too many ways of going wrong. Don't ignore this vital component of your portfolio just because it lacks the excitement of the stock markets.