They say your investment portfolio is a reflection of yourself, and if you ever intend to play the market, your understanding of the self should be perfect — especially with respect to your needs, objectives, resources, liabilities and other constraints, all of which are unique. The one big factor that merits particular attention is the time you have at your disposal. More specifically, a wise investor must consider time his best ally.
Let’s utilise the idea captured in the earlier paragraph to dwell on a rather tricky matter — time horizons with regard to various investment products. This relates to the understanding of a significant concept: an investor must allocate resources in the most optimum manner so that a particular investment product is allowed the time it deserves; not more, not less.
Okay, having said that, let’s consider the demerits of over-indulgence, that is, giving more time than what is needed for a certain product to deliver maximum returns. Or, the demerits of under-indulgence when the opposite is done — time so insufficient that it hurts the potential to perform. In both cases, there is inadequate utilisation as the intrinsic objectives of the investment concerned are not achieved.
As we have seen time and again, investors often tend to make a fundamental mistake — parking short-term money in what can be typically billed as longer-term products, and long-term money in shorter-term options. This is patently wrong.
Know your time horizon
This brings us to a critical point, namely an acute knowledge of the time horizons applicable for various investment products. As you may have already guessed by now, the issue we are raising here is related to debt market products, which collectively account for an overwhelming share of the entire investment universe.
Compared to equity and equity-linked alternatives, a familiarity with time horizons for debt (after all, there is a distinct shelf-life to consider in each case) is a lot more critical. In other words, an investor would do well if he knows the ideal holding period for each category of debt.
We can, at this stage of our discussion, relate instantly to the kind of debt funds that exist in the market, ranging from the very short-term ones such as liquid and money market funds to the very long-term ones such as longer term income and gilt funds (See chart).
Remember, debt represents fixed-income securities, typically interest-bearing in nature. This implies that an investor is rather aware of the approximate returns he would receive from time to time (or at the time of maturity). As with other asset classes, your choice of debt should be principally based on your investment horizon, liquidity needs and appetite for risk.
Therefore, it stands to reason that an investor must never buy into a long-term income option if his horizon is a lot shorter, say, six months. Similarly, there is little logic in placing your money in low duration funds, the money that you may require after five years. Both would serve as tragic flaws insofar as the overall yield of your portfolio is concerned.
Risk-return trade-off
As an extension of what we have maintained so far, an investor must have clear expectations from the risk-return grid in which he is placed. In this connection, he needs to remember a few straight points:
- Debt can be quite volatile too — its yield would depend on so many factors linked to the market. Adverse interest rate movements and credit quality issues can spoil the fun for a typical debt investor.
- For specific time horizons, there are specific kinds of products to consider. Match your debt’s characteristics to your needs. Your selection would determine success or failure.
- Keep liquid and money market funds to tide over emergencies; don’t over-indulge in them if you need the proceeds after a year or so. Further, if you have a lower risk appetite and wish to generate stable income, aim at shorter maturity alternatives with a manageable credit risk exposure.
- Longer duration funds may deliver superior returns when interest rates decline but could also be adversely impacted when interest rates increase. It is the same with credit risk funds (which seek to compensate the risk of allocating to lower rated paper with higher returns). However, they can get a positive impetus during credit upgrades (and are negatively impacted when a downgrade happens).
Your strategy
An investor needs to plan well if he wishes to get the best out of debt by way of compromise on stability and liquidity. Given these constraints, he needs to be disciplined enough to imbibe the following learnings:
- At least 15 per cent of the portfolio should be geared towards handling of emergencies. To achieve this, a proper selection of only liquid and money market funds is necessary.
- To meet foreseeable expenses, like payment for real estate, a mix of short-term funds can be considered. These should be stable enough, and not far too wavering in terms of returns. May be 40 per cent of your money can be reserved on this front.
- For longer term expenditure, a few income and gilt funds can be weighed. The proceeds from their redemption can go towards meeting higher education targets or marriages. In our example, this is the rest 45 per cent.
These are mere ballpark figures based on sweeping assumptions, which an average investor may still find useful. Each individual is uniquely placed in life, and there is no common size to fit all. Therefore, each plan must be tailor-made, worked out in line with one’s own time constraints.
The writer is director, Wishlist Capital Advisors
The writer is director, Wishlist Capital Advisors