Which debt instrument is right for you?

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With so many fixed income instruments now available to us we sure are spoilt for choice. However how does one decide which one is better than the other? Is it merely on the basis of the interest rates they offer? What other attributes should one consider before investing?

 

 

We at Fpguru.com would like to bring to your notice a few important fixed income instruments and compare them in order for you to know points to consider while making an investment.

 

Fixed Deposits are the most common avenue for us to park our funds. This is where you deposit your money in a bank for a time period for which you earn a fixed interest till maturity. Higher the time period, higher is the rate of return.

 

Most of us believe fixed deposits to be the safest and the easiest instruments to invest in. Standing by their reputation, they offer customers a safe avenue to invest however, offer low rates as compared to riskier instruments.

 

In case of breaking a Fixed Deposit before maturity, a penalty is charged or you are entitled to a rate of return corresponding to your holding period.

 

Corporate Deposits are similar to bank Fixed Deposit’s but are offered by companies. This is when you keep your money as a deposit with a company in return of a fixed interest payment. However these can be unsecured, which means you do not own any asset of the company in case the company winds up.

 

Because these deposits these can be unsecured, they offer a higher rate of return as compared to fixed deposits. This also helps in distinguishing which corporate deposits are safer than the others. All corporate deposits have to be necessarily rated by credit rating companies. Thus while selecting a company deposit; one must always consider the one which is secured & has a better rating to be safer.

 

Corporate Deposits can also pose a problem in case of premature withdrawal. It isn’t as simple as breaking a bank FD, and may not have any premature withdrawal option.

 

Debentures are basically loans given to companies. This is debt for the company, for which the holder is entitled to a fixed interest payment for a fixed period of time. Government Bonds too are similar, only instead of company you have given a loan to the Government.

 

The instrument which creates this debt for the company is called as a debenture. Most debentures have the option of converting into shares of the company after a fixed time. However certain debentures cannot be converted into shares. These are called non-convertible debentures.

 

Debentures holders are given first preference in case of a company winding up. These too can be secured or unsecured.  Debentures can be cumulative or payout types. In cumulative the interest earned every year is kept with the company & re-invested which means you are earning interest on interest. In payout option you receive your interest payouts regularly. Cumulative option has a higher effective yield, i.e. you earn more on them.

 

Liquidating your NCD’s used to be a problem earlier. You cannot redeem it before the maturity or put date. This used to be a roadblock for investors wanting to but such instruments. However nowadays all such instruments are listed on stock exchanges, which means you can sell these debentures in the open market if you want to encash your investments. The only thing to keep in mind is the liquidity of the debenture in the exchange. If there is a good demand for it, it will sell easily.

 

Debt Mutual Funds are Mutual fund schemes which invest in various debentures, bonds, etc on your behalf.  If you are unaware of which debt instruments to invest in, you can simply invest in Debt Mutual funds.  There are various types of debt mutual funds. The advantage is that a fund manager is actively tracking your investments, which you may not have time for.  The disadvantage being that there are expenses & fees charged by the Mutual Fund for this. However they make good sense for investors with lack of time or knowledge to invest.

 

Investing is a subjective matter and does not simply depend upon the rate of return offered by any one instrument. Investors who have a very low appetite for risk must most definitely stay away from Corporate Deposit’s. Also those requiring money for a very important goal must also try and avoid these instruments.

 

Those willing to take moderate risks can venture into the NCD’s space. CD’s, being risky & illiquid instruments are generally to be stayed away from.

 

All in all, in order to ensure you are safe as well as earning a decent rate of return, it is a must to diversify and park your funds in several different instruments. Hence a moderate exposure to the NCD or Debt Mutual funds space along with a portion of your funds as Fixed Deposit’s, should do the job. Do keep your investment time horizon in mind & plan the same!

 

By Shalmali Kulkarni.

The writer is working as a para-planner with Fpguru.com


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