scorecardresearchFinancial Planning: How do you diversify a fixed income portfolio into

Financial Planning: How do you diversify a fixed income portfolio into different buckets?

Updated: 27 Sep 2022, 10:29 AM IST
TL;DR.

It is essential to demarcate the fixed income portfolio into different buckets with different use cases.  Read further to know more

Bucketing of Fixed Income Portfolio

Bucketing of Fixed Income Portfolio

Fixed income instruments play an important role in one's personal finance.  As a part of the financial planning process, it is essential to demarcate the fixed income portfolio into different buckets with different use cases. 

  1. Liquidity bucket (Emergency Fund Bucket) for emergencies
  2. Core fixed income bucket for goal planning, tax savings, better tax efficient returns and to provide stability to the overall portfolio (asset allocation).
  3. Satellite bucket - to take tactical calls.

Emergency funds

This bucket is meant to take care of all sorts of emergencies from a job loss to prolonged sickness. We believe that you must take care of two things when setting up your emergency fund.

Firstly, the money must be accessible at a short notice and secondly, the money must not lose value over time due to inflation. The second part is most important because if you hold the funds in a savings account or a fixed deposit and if an emergency never arises, you will need to continuously top up the emergency funds every few years. A better strategy would be to invest up to 3 months of emergency funds in a fixed deposit and the balance in conservative hybrid funds that will give higher post tax returns.

  • Conservative hybrid funds will become tax efficient in three years.
  • Fixed deposits can be liquidated anytime through net banking.
  • Choose those conservative hybrid funds which have equity allocation of less than 15%

Core fixed income basket

This basket, if constructed smartly, can save a lot of taxes, can be aligned to different financial goals and plays an important role from an asset allocation point of view.

Three instruments that are no-brainer and you must not miss while planning your investments in this bucket are Public Provident Fund (PPF), Employees Provident Fund (EPF), and Tier 1 of the National Pension Scheme (NPS).

All three vehicles PPF, EPF and NPS enjoy EEE status i.e. they get tax deduction at the time of investment, interest earned is tax free, and maturity proceeds are also tax exempt. Lastly, if you have a daughter, and want a higher allocation in your core fixed income basket, you can also consider Sukanya Samridhi Yojna which also has EEE status.

The above vehicle may be enough for a normal retail individual but for people with higher investible surplus, incremental fixed income allocation can go into target maturity funds (mapped to financial goals), schemes following roll-down maturity, G-Sec ETF and open-ended funds with high portfolio quality (low credit risk) and low average maturity (low interest rate risk). 

For senior citizens looking for consistent pay-outs, there are products like RBI bonds, Pradhan Mantri Vaya Vandana Yojana, Post office senior citizen scheme are some of the good investing options.

  • Stay away from guaranteed return products offered by life insurance companies.
  • Annuities should also be avoided as they are very tax and return inefficient.
  • In NPS, we are only referring to the fixed income portion of the allocation.

Satellite bucket

Although, a retail investor doesn’t need this bucket. You must have a fair understanding of global and local macroeconomic scenarios to take advantage in this bucket. This bucket is only for investors with a decent amount of investible surplus and must be created in professional guidance only.

Satellite bucket is to take advantage of interest rate movements or to play the credit cycle. Wealthy people use this bucket mostly with tax free bonds (to play the interest rate cycle), market linked debentures (for short term tax efficiency) & long duration and credit risk funds. 

For example, if you believe that interest rates are set to fall, you can consider investing in medium to long term bond funds that will provide higher returns in such a scenario.

  • Risk is too high in lower rated bonds launched by new age platforms.
  • Annuities should also be avoided as they are very tax and return inefficient.

Nishant Batra CWM® is Chief Goal Planner of Holistic Prime Wealth.

Disclaimer: The views expressed in this article are of the author, not MintGenie.

Article
What is emergency fund?
First Published: 27 Sep 2022, 10:29 AM IST