13 Sep 2020

But why is volatility in debt investment bad?

In an earlier blog post, I said this:

The way I invest—and most of us do—is to use the debt portion of the portfolio for stability while using the equity portion to bring in earnings/growth. Taking risks in debt funds for the sake of getting better returns is simply forgetting why you have an equity/debt split to begin with.

In this post, let us think about the rationale behind this principle. Before we start, let me expand on what I meant when I said “the way most of us invest”. The idea here is that:

  1. As our financial goals are approaching, we’ll be moving money from volatile investments such as equity and gold over to debt investments.
  2. By the time we want to spend the money on a financial goal, we’ll only be redeeming debt funds because 100% of the corpus for that goal should now be in debt.

My goal’s asset allocation glide path is designed in such a way that as the goal approaches, money is gradually moved from equity investments over to debt. I use my own asset allocation glide path, but if you use Kuveras goal planning, Kuvera will guide you through its own proprietary glide path. Follow the asset rebalancing advice that they regularly send, and your investments will follow their glide path. (Shameless plug: if you are new to Kuvera, sign up using my referral code JK1P3 to get Kuvera Coins worth ₹100.)

With these assumptions stated, let us look at an example. Let’s say I need 20 lakhs for my son’s college fees that’s due next month. I will have all of this 20 lakhs in debt funds, thanks to the glide path. Let’s say this is a volatile debt fund, and it loses 5% before the due date. Now the debt investment is worth only 19 lakhs! The fund might eventually recover if I stay invested for a few more months, but my son’s college will not wait. I’ll have to scramble to arrange the lost 1 lakh from some other source. This is essentially the reason for choosing a more stable debt investment over a more volatile one.

The natural question that follows is what if your goal is 10 or 15 years away and you’re not really going to spend the money any time soon? Can you invest in riskier debt funds and move them gradually to safer debt funds? You can. But then your glide path becomes complex; your portfolio will have more churn because you are not rebalancing between 2 buckets (equity+gold and debt) but 3 (equity+gold, high risk debt, and low risk debt). If you are okay with more risk, why not just invest in equity for a longer period? Your glide path remains simple and yet you take more risk in the initial days by having a larger allocation to equity+gold.

Investment is a very personal exercise. There are many “best practice” advices, but there is no single rule for how exactly to do it. Think about your desires and preferences and choose a path that’s just right for you.

12 Sep 2020

Are debt mutual funds better than bank fixed deposits?

A friend of mine read my post on debt funds and asked me this question. “If you shouldn’t be optimising your debt portfolio for return, why not just put the money in bank fixed deposits (FDs)? Are there reasons to choose debt mutual funds over bank FDs?”
A very good question. Putting higher returns aside, are there reasons to invest in debt mutual funds rather than investing in FDs?
I can think of the following reasons:
  • Diversification. With an FD, you trust that a certain bank (or a few banks) will be able to repay you. It’s arguably not a huge risk that a bank will go insolvent, but the risk is nonzero. With debt mutual funds, your money is invested in several bonds/CDs/CPs/etc so the risk of any one—or a few—institutions going insolvent is mitigated. You might lose, say 5% of your capital but not 50 or 70%.
  • Convenience. If you were to invest in FDs, you need to decide which bank, for how long, etc at the time of investment. When you buy debt mutual funds, you don’t need to make those decisions. The fund manager makes those decisions for you. You pay the fund manager for this work, of course, through the fund’s expense ratio. But the convenience is worth the money in my view.
  • Income tax. If you have an FD for 10 years, you’ll be paying taxes every year for the accrued interest. With debt funds, you don’t have to worry about taxes until the time you redeem the funds. Also, taxation of long term debt mutual funds is not at slab rate, which can be a big plus for people who are in the highest tax bracket; it’s less of an issue for people with low tax liability.
  • Restrictions imposed by FDs. This is just a combination of convenience and rate of returns. Let’s say you have 10 lakh rupees in 10 FDs: 1 lakh each. You need to withdraw ₹70,000 for some expense. Now you can break one FD and re-deposit the balance ₹30,000, but you’ll lose any unpaid interest for the deposit, including for the ₹30,000 you will be re-depositing. You can maybe ignore the interest loss, but you really have to think and decide how to reinvest this ₹30,000. For example, how long to invest, should this be a single ₹30,000 deposit or a few deposits of lesser amounts, etc. If the same 10 lakhs was in a debt mutual fund, you simply redeem ₹70,000 and that’s the end of the story.

5 Sep 2020

Which is better — gold mutual fund or digital gold?

Until I read this piece on Kurva Blog, I was only mildly interested in gold. After reading that, I thought I’d invest in gold because it acts as a hedge against INR currency depreciation and inflation to some extent. I thought digital gold was the way to go because they are better than gold ETFs or gold mutual funds in these ways:

  • no recurring expense though you pay 3% GST at the time of purchase, and
  • the Kuvera blog post said digital gold tracks gold price more closely than other gold instruments.
I started a digital gold SIP and started buying gold every month. Only a few months later I realised that digital gold is a space that is not regulated by the government. This was concerning. From some online sources I found out that digital gold providers have set up regulatory processes by hiring third-party auditors, etc. That’s better than nothing, but that is still voluntary. If a vendor finds some process too inconvenient, they can decide to not do it; no one can question them.
•••
Quantum is an AMC that I am starting to like more and more for their conservative and responsible approach to handling investor’s money. Quantum has a gold mutual fund. They conducted an online session where they outlined the process they have for acquiring and storing the gold that their investors buy. I watched that live and from then on, I decided that I’d rather invest in gold through Quantum than anyone else. First of all, the mutual fund industry is regulated by SEBI, which is far better than self regulation. The next reason is very subjective: I happen to like and trust Quantum more than many other AMCs.
Thus, I switched my allegiance from Kuvera provided digital gold to Quantum gold mutual fund. I knew I was losing some money because the fund’s expense ratio pays for insurance, storage, AMC’s regular inspection and auditing, etc. But I convinced myself that the peace of mind I get is worth the money.
•••
Just today, I came across another reason that validates my decision to move away from digital gold. It’s an article on LiveMint, and it says:
Generally, these digital gold products have a maximum holding period after which the investor has to take delivery of gold or sell it back. For example, MMTC-PAMP investors will have to mandatorily take delivery or sell the gold purchased, unlike gold ETFs where there is no such limitation. After five years, the investor will have to pay extra charges decided by MMTC-PAMP, if the delivery is not taken. One can hold Gold ETF for as long as one wants to.
If you want to hold on to your gold for longer, you need to sell and repurchase the same gold at the 5 year mark. It sounds like a simple annoyance, but if you think a little bit more, you’d realise it’s more than an annoyance:
  • If you’re selling and repurchasing, you will be paying the 3% GST again. The narrative that digital gold has an one-time overhead (GST) vs mutual funds having a recurring overhead (expense ratio) breaks down here. (The magnitude of the recurring cost can still be different.)
  • Add to that the spread that exists between the selling price and buying price. Let’s say you need to sell 3 grams of gold because you have held them for the maximum holding period. Thanks to the bid-ask spread, the money you got from the purchase will get you less than 3 grams of gold. This is even before accounting for the 3% GST.
  • Selling gold is a tax event. You need to determine whether it’s a capital gain or loss and include that in your tax returns. If there was capital appreciation, you’re also looking at a tax bill in addition to the aforementioned expenses.
This only strengthens my belief that picking the right investment instrument is really hard, but not for the lack of information. You can find any information you need on the web. Most vendors will also be happy to answer your questions if you just call them. But your needs and preferences are unique. Speak to knowledgeable people you know or a financial advisor, and find out what works best for your own unique needs.
PS: If you’re still not sure whether to invest in gold (more precisely, to have an allocation for gold in your portfolio) I would highly recommend reading Kuveras excellent advice on this. Gold has historically given less return than equity. If you have an allocation for gold, you should be prepared to sell some equity and put that money in gold. You should be willing to go through that unpleasant exercise.