- Date : 10/03/2017
- Read: 4 mins
As an investor, one always wishes for the best returns from investments without any risk of losing money. However, it is common knowledge that there doesn't exist any such investment product. In reality, risk and returns are inversely related, i.e. with more risk come higher returns and vice versa.
The decision to choose between the two is fairly simple. For a goal that is still a few years away, the reason to take risk might still exist while for goals that need attention within a few months or years, it could really be a risky venture.
For investors, the choice between fixed-income investments and market-linked investments becomes more pronounced when it comes to meeting goals. Let's see what they are and how different investment avenues may be put to use while chasing goals.
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Fixed-income investments: Interest-bearing investments such as bank fixed deposits, company deposits, post office small savings products and bonds are popular among fixed-income investors. They come with a fixed return and a pre-decided maturity period. They, therefore, belong to the debt-asset class. According to Vivek Karwa, Certified Financial Planner, Investment Adviser & Portfolio Manager, "You should be investing in these only when the requirement is fixed and certain in the near future since you need a sure shot cash flow and can't risk any volatility."
The principal amount invested is fairly safe in such products. They, however, fail to generate high real returns, i.e. returns adjusted to inflation are low in such fixed-income investments. For example, if the return generated from them is 7 per cent while inflation is 6 per cent, the real return will be around 1 per cent. At the most, such instruments help in preserving capital and providing a regular flow of funds to meet monthly household requirements.
Market-linked investments: When returns depend on the performance of the underlying asset, which could be equity or debt, it is the case of market-linked investment. Returns, therefore, are neither fixed nor assured. Equity shares, mutual funds, Ulips, NPS are all examples of market-linked investments. As they are high-risk products, the potential to generate high return is also there.
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Role of market-linked investments: As fixed income investments generate low real returns, it is imperative for an investor to look at equities. Karwa says, "In case you are young and have no responsibilities in the near future and can afford risk taking, then investing in fixed income securities will not take you anywhere. Keep in mind that post taxation you may not even beat the inflation."
Market-linked investments, especially those made in equities as the underlying asset class, are more likely to deliver high real returns. For this to happen, the holding period of equity should be long enough to ease out the volatility associated with equity. The more away the goal to be achieved is, the more reliance can be placed on equity-backed investments. Karwa says, "Every product has its own cycle with its underlying factors changing. Proper investing based on time cycle and risk can help you beat inflation and give you real growth. If you have a horizon of 3+ years, then go with market-linked products. You will surely require some expert advice here." Be it one's child education, marriage or one's own retirement, equity plays an important role in creating a decent corpus even with smaller amount of regular savings.
Taxation: While choosing an investment product, taxability of the specific investment is equally important. The interest income from most fixed-income investments such as bank deposits, post office time deposits, NSC, KVP and bonds is fully taxable as per the income tax slab of the individual. The post-tax return from them therefore is much less than what they offer. Although interest is taxable, the 5-year tax-saving bank fixed deposit and post office 5-year time deposit qualify for tax deduction under section 80C of the Income Tax Act, 1961. PPF and tax-free bonds yield tax-free return while the former also gets tax advantage under section 80C.
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Equity-oriented investments such as equity mutual funds, Ulips and NPS are more tax-friendly. The gains after holding them for a longer duration are tax-free except in NPS wherein it is partially taxable. Equity-linked savings scheme (ELSS), a variant of equity mutual fund, provides exposure to equities, gives tax-exempt return and even helps in reducing one's tax liability under section 80C. Ulips offer similar benefits and in addition, provide protection through life insurance.
Conclusion: For an investor chasing long-term goals, it is important to make the best use of both the worlds. Both fixed-income and market-linked investments have a role to plan in the process of wealth creation. While market-linked investments help in navigating the volatility and in the process generate high real return, the fixed income investments help in preserving the accumulated wealth so as to meet the desired goal. In times when interest rate is on the down side, choosing between fixed and market-linked investment avenues should not be so difficult.
(Readers are advised to consult their tax advisor for detailed advice.)
Source: Economic Times