Consider these 9 things before investing in mutual funds!

When it is time for the Reserve Bank of India’s monetary policy, most individuals keenly await a cut in interest rate. Who does not want lower rate of interest on their loans, especially home loan? But rarely individuals get into details and see it from the side of returns on investments.

Governor, RBI, Shaktikanta Das today announced the consumer price inflation (CPI) expectations for next year. CPI inflation is now projected as 5.0 percent in Q4:2020-21; 5.2 per cent in Q1:2021-22, 5.2 per cent in Q2, 4.4 per cent in Q3 and 5.1 per cent in Q4, with risks broadly balanced. This means inflation is expected to remain around 5% till the end of financial year 2021-22.

Low FD returns
Now compare this with one year fixed deposits. State Bank of India offers 5% and postal time deposits offer 5.5%. If you are a senior citizen the bank may offer you a quarter percent more. However, in case one chooses to invest in aforementioned investment options involving little credit risk, there is nothing left in his hand. The real yield in case of SBI fixed deposit is zero and in case of postal time deposit maturing in one year it is 0.5 percent. Real yield is arrived at by deducting the rate of inflation from the nominal yield.

The worst part is, if we take into account taxation, then the return falls further. Interest is added to the income of the individual and taxed as per slab rate. That leaves investors poorer. In the first place, they make very low returns and on top of that they have to pay tax on it.

“Unfortunately these are not the best of times for fixed income investors. Also going forward it is not going to be a great place soon” Anil Rego, Founder and CEO, Right Horizons, said.

The few options left
In the view of low real yields, investors have to get their acts right. While there are options like senior citizen saving schemes and Pradhan Mantri Vaya Vandana Yojana that leave some money on the table post inflation and tax, there is not much left for non-senior citizen investors. “Small saving schemes such as Monthly Income Schemes which give around 6.6 percent or longer term PPF at 7.1 per cent with tax free returns are among the very few options,” Rego said

In such a situation, individuals have to make a few choices. First there is no point chasing yield. There are bonds and fixed deposits that offer higher yield. But do check their credit rating. In most cases they are rated low as these instruments carry higher credit risk compared to a bond rated AAA or a bond issued by a sovereign. Investors should refrain from bonds offering too high a rate of returns. These could be possible default candidates.

If you are keen to take some credit risk, look for relative risk. For example, it pays to invest in postal time deposits instead of SBI fixed deposits, as the former offers tad more at the same level of risk. You may consider investing in HDFC fixed deposit over HDFC Bank fixed deposit for the same reason. Such moves can help you pocket a little bit more, without taking extra risk.

The credit risk fund option
However, it does not help you beat inflation by a wide margin. If you are keen to take credit risk, then you are better off investing in a well managed credit risk funds of reputed mutual funds. Take at least a three year view, to ride out volatile phases. “If you invest in credit risk funds you should choose funds which hold good quality AA rated papers. If they hold papers with lower ratings then the risk will be very high,” S Sridharan, Founder, Wealth Ladder Direct said.

While investing you should also beware of interest rate risks. Some low rated NCD may offer high or attractive rates for a long period of time. In rising interest rate scenarios, it may make little sense. Also avoid investing in gilt funds just because they carry no credit risk and they have done well over the last 3 years. They are exposed to higher interest rate risks.

Should you switch to equities?
Also a word of caution for those keen to switch from fixed income to equities just because fixed income instruments have turned unattractive. You must understand the risks in equities. If you are risk averse, it may be better to take a long term view and invest in a staggered manner in diversified equity funds using systematic transfer plans. Ideally stick to your asset allocation. But if the situation demands, then do allocate some extra capital to equities. Do not shun fixed income altogether. Especially, if you are investing for a short term – say up to three years, you are better off with fixed income.