Do not be a sitting duck when interest rates fall
It is easy to figure out what your fixed income portfolio looks like.
|Instrument||Weight in portfolio %||Yield %|
|Bank depsoit, Liquid Funds||60%||8%-9%|
|Total return at mid range||100%||8.95%|
The weights might differ from portfolio to portfolio, the instruments will be the same. A very few enlightened investors may have investments in bonds or funds that investment in longer maturity bonds.
What is wrong with the portfolio given here? After all it is earning around 9% which while not great in such inflationary times is not too bad either. These investments are also capital protected and you need not worry about your capital being eroded. This portfolio is locked on to interest rates and carries the view that interest rates will go up further or stagnate at higher levels for a while. At times of rising interest rates, such a portfolio may make sense, but at a time when inflation looks to be peaking, this portfolio is a definite underperformer. Read the note on why it is good to extend maturity of your portfolio .
Your fixed income portfolio right now will typically have a maturity of less than three years (apart for government run savings schemes) , is illiquid as the investments cannot be broken without paying a cost and is a sitting duck when interest rates fall. If interest rates fall by 1%, your portfolio will underfperorm a direct investment in ten year credit risk free government bond by a whopping 6%. Mutual funds that invest in government and corporate bonds charge fees of 2% and even after paying the fees, returns can potentially be around 13% over a one year period.
It is time to shift your fixed income portfolio. Given that you do not have experience In investing to capture fall in interest rates and do not know the risks involved (potentiall short term capital loss if interest rates rise rather than fall), you need not shift out fully into longer maturity products. A portfolio such as the one suggested below will do you well.
|Instrument||Weight in portfolio%||Expected return%||Expected Returns % in adverse reaction of 1% rise in rates|
|Long maturity instruments. Bonds, income, gilt funds||40%||13% – 15%||1%|
|Short maturity instruments. Bonds, short term funds||20%||10%-12%||3%|
|Fixed, deposist, FMP’s, Liquid funds||20%||8%-9%||8%-9%|
|Total mid range||100%||11.25%||4.45%|
If interest rates rise by 1%, which is adverse for the above portfolio, the returns will be 4.45%. The above portfolio is not for times when inteerst rates are rising. The current period is a time when interest rates are peaking or have peaked and rates are more likely to fall from peaks than trend higher. Shift into the above portfolio now for good returns with lower levels of risk.