Deciding where to invest is never an easy decision. Even when you know how much you wish to invest, your mind keeps oscillating between various investment options considering how quickly and safely you would like to reach your financial goals in the future.
Selecting the appropriate investment vehicle can prove to be a formidable challenge, particularly for those new to the investment world. Numerous variables warrant consideration, including your financial objectives, tolerance for risk, and investment timeframe. Before reaching a decision, it is crucial to conduct thorough research and gain a comprehensive understanding of the various investment choices at your disposal.
Below are some guidelines to help you select the appropriate investment vehicle:
Underline your financial goals: Begin by clearly outlining your financial objectives. What are you setting money aside for? Is it a home down payment, retirement, or your child's education? Once you have a clear understanding of your goals, you can proceed to refine your investment choices accordingly. Once you've established your financial objectives, you can initiate your investigation into investment vehicles that align with your risk tolerance and investment timeline.
Evaluate your tolerance for risk: Risk appetite refers to the level of risk an investor is prepared to embrace in pursuit of their financial objectives. It is essential to assess your risk appetite prior to selecting investment instruments, as certain investments inherently carry more risk than others. Several factors can shape your risk appetite, including your age, investment timeframe, financial status, and personal inclinations.
Consider your investment timeframe: Prior to selecting investment instruments, it's crucial to contemplate your investment horizon. Certain investments are better tailored to long-term investors, while others are more suitable for those with shorter timeframes. When making investment choices, it's vital to take your investment horizon into account and ensure that your selected assets align with your intended timeframe.
Floater funds versus fixed deposits
In India, floater funds and fixed deposits stand out as two prominent investment choices. Each possesses its distinct set of advantages and disadvantages, necessitating a thoughtful selection based on your financial objectives, risk tolerance, and investment horizon.
Floater funds represent a category of debt mutual funds that primarily allocate capital to floating rate instruments, including floating rate bonds and bank loans. These instruments feature interest rates that adjust periodically, often every three or six months, in alignment with a benchmark interest rate, such as the LIBOR rate. Consequently, the returns on floater funds can fluctuate in response to changing interest rates.
On the other hand, fixed deposits constitute a form of savings account that offers a fixed interest rate for a predetermined duration. FDs are typically regarded as a secure investment option since both the principal amount and the interest earned are guaranteed by the bank or financial institution.
Benefits of investing in floater funds
Before you discard floater funds as just another kind of debt fund instrument, know how these instruments can yield good returns while helping you reach your financial goals without involving too much risk stemming from market volatility.
High-interest rate benefit: Floating rate funds tend to yield higher returns when interest rates experience an upswing, given their investment focus on floating rate instruments like floating rate bonds and bank loans. These instruments periodically reset their interest rates, usually every three or six months, based on a benchmark interest rate, such as the LIBOR rate. Consequently, the returns on floating rate funds can vary in tandem with changes in interest rates.
Floating rate funds can prove to be an attractive investment choice when there are expectations of rising interest rates. However, it's essential to bear in mind that they come with greater risk compared to fixed deposits, as their returns are susceptible to fluctuations in interest rates.
Liquidity: In the context of liquidity, floater funds offer greater flexibility compared to fixed deposits. Fixed deposits typically come with a lock-in period, meaning you cannot withdraw your funds without incurring a penalty until the lock-in period has concluded. In contrast, floater funds can be redeemed on any business day.
This renders floater funds a more suitable choice for investors seeking quick access to their funds. For instance, if you are building an emergency fund, opting for floater funds may prove more advantageous than fixed deposits, as they allow you to swiftly access your funds in case of an urgent need.
Inherently less risky: Floater funds typically diversify their investments across various debt instruments as a strategy to mitigate risk and potentially enhance returns.
These funds commonly allocate their investments to a range of floating rate instruments, including floating rate bonds, bank loans, and commercial paper. Floating rate instruments feature interest rates that adjust at regular intervals, often every three or six months, in accordance with a benchmark interest rate like the LIBOR rate. Consequently, the returns on floater funds are subject to fluctuations in interest rates.
Nevertheless, by spreading their investments across different debt instruments, floater funds can diminish their overall risk. This approach is effective because when the value of one debt instrument experiences a decline, the value of others may rise, helping to offset losses and safeguard the investor's capital.
Furthermore, floater funds possess the potential to yield higher returns compared to alternative forms of debt investments, such as fixed deposits. This potential stems from the fact that the interest rates on floating rate instruments can ascend in tandem with market interest rates. Consequently, the returns on floater funds can increase during periods of rising interest rates.
Cons of investing in floater funds
Not everything is hunky dory about floater funds. These funds have their disadvantages too, which investors must be aware of before putting their money in them. Agreed that these funds have their disadvantages too which may cause people to either lose their money or delay their financial journey.
Fluctuating interest rates: Interest rates on debt instruments within floating rate funds are variable, which means they can decline over time and impact overall returns. Floating rate funds primarily invest in floating rate instruments, including floating rate bonds and bank loans. These instruments reset their interest rates periodically, typically every three or six months, based on a benchmark interest rate, such as the LIBOR rate. Consequently, the returns on floating rate funds are subject to fluctuations in interest rates.
In the event that interest rates decrease, the returns on floating rate funds will also decrease. This reduction occurs because the interest rates on the underlying debt instruments will similarly decline.
Hence, it is crucial to be mindful of the associated risks before considering an investment in floating rate funds. One of the principal risks to consider is that returns on these funds can decrease when interest rates experience a decline.
Lack of safety: Investing in floater funds carries the potential risk of losing your investment if the issuer fails to meet its financial obligations. This risk is commonly referred to as credit risk, which pertains to the possibility that the issuer of a debt instrument may not fulfill its obligations, including making interest payments or repaying the principal amount of the debt.
Floater funds typically diversify their investments across various debt instruments, such as floating rate bonds, bank loans, and commercial paper. Some of these debt instruments may be issued by companies or entities with lower credit ratings, indicating a heightened credit risk.
In the event of an issuer defaulting on its obligations, the value of the debt instrument will decline, potentially leading to financial losses for investors in the floater fund. Furthermore, it's crucial to recognize that credit risk cannot be completely eradicated. Even entities with strong credit ratings can still face the possibility of defaulting on their obligations.
Variable return rates: Floater funds are susceptible to market fluctuations and alterations in interest rates arising from policy decisions. This susceptibility stems from the fact that floater funds allocate their investments to floating rate instruments, such as floating rate bonds and bank loans. These instruments feature interest rates that adjust periodically, often every three or six months, in accordance with a benchmark interest rate like the LIBOR rate. Consequently, the returns on floater funds can vary in sync with changes in interest rates.
One primary risk lies in the unpredictability of floater fund returns, given their reliance on interest rates. This unpredictability can pose challenges when making investment decisions. Additionally, floater funds carry the risk of greater volatility compared to other forms of debt investments, such as fixed deposits, due to the potential fluctuations in returns tied to changes in interest rates.
How does putting money in FDs help?
Fixed deposits offer a fixed interest rate for a predetermined period of time. This means that the bank or NBFC is obligated to credit the interest accrued within the chosen time frame, even if the interest rate fluctuates after you invest in the FD scheme.
Low risk option: Fixed deposits present a relatively low-risk investment choice, given that both the principal amount and accrued interest are safeguarded by the bank or non-banking financial company (NBFC). Furthermore, FDs generally offer greater liquidity compared to alternative debt investments, such as bonds, permitting premature withdrawals with a penalty. However, it's worth noting that FD interest rates are typically fixed for the entire deposit term, which means investors may not benefit from rising interest rates.
Secured investments: In summary, FDs can prove to be a suitable investment avenue for those seeking security and guaranteed returns. Nonetheless, it is prudent to assess and compare the interest rates provided by various banks and NBFCs before committing to an FD scheme.
Though investing in FDs is a relatively low-risk investment option as the returns are guaranteed, it is important to note that the interest rates on FDs are typically lower than the interest rates on other types of investments, such as stocks and mutual funds.
Why not all money must be invested in FDs?
Fixed deposits differ from floater funds in their investment approach, as they do not diversify your funds across a range of investment instruments. Instead, fixed deposits generally invest in debt instruments issued by a single entity, like a bank or NBFC. This limited diversification results in fixed deposits typically offering lower potential returns compared to floater funds.
Also, these deposits commonly come with a predetermined lock-in period, during which you cannot access your funds without incurring a penalty until this period has elapsed. In contrast, floater funds offer greater flexibility, allowing for redemption on any business day.
How to decide between floater funds and fixed deposits?
Floater funds represent a category of debt mutual funds specializing in investments in floating rate instruments, such as floating rate bonds and bank loans. These instruments periodically adjust their interest rates, typically every three or six months, in line with a benchmark interest rate, such as the LIBOR rate. Consequently, the returns on floater funds are susceptible to fluctuations driven by changes in interest rates.
On the other hand, FDs serve as a type of savings account that provides a fixed interest rate for a predetermined duration. FDs are commonly perceived as a secure investment choice, given that both the principal amount and accrued interest are guaranteed by the bank or NBFC.
Floater funds offer:
- Potential for higher returns
- Greater risk compared to fixed deposits
- Exposure to market volatility
Fixed deposits offer:
- Lower returns
- Lower risk in comparison to floater funds
- A stable source of income, making them favoured by conservative investors
Conversely, floater funds present the potential for enhanced returns, albeit with a commensurate increase in risk. This heightened risk arises from the fact that floater funds primarily invest in floating rate instruments, such as floating rate bonds and bank loans. These instruments feature interest rates that recalibrate periodically, typically every three or six months, in alignment with a benchmark interest rate, such as the LIBOR rate. Consequently, the returns on floater funds can oscillate in tandem with fluctuations in interest rates. Here are some factors to consider:
Historical performance: It is crucial to emphasize that past performance serves as an imperfect predictor of future outcomes. Thus, the fact that floater funds may have outperformed fixed deposits in the past does not guarantee a continuation of this trend in the future.
Market sentiments: Market sentiments can exert a substantial influence on investment returns. For instance, in a bearish economic environment, investors might opt to sell their floater fund holdings, leading to a decline in the prices of these investments and a subsequent reduction in returns.
The choice between investing in floater funds or fixed deposits should hinge on your unique financial requirements and your comfort level with risk. If you seek a low-risk investment vehicle with assured returns, then a fixed deposit may align well with your needs. Conversely, if you are searching for an investment that offers the potential for higher returns and are open to assuming greater risk, then a floater fund might be a more suitable choice for you.