Risk Profile And Needs Determine Your Investment Style

I am 27 years’ old. My parents are suggesting that I invest my savings in traditional products like FDs, endowment policies and PPF since they believe that equity and debt securities are risky. But I want to invest in mutual funds backed by equities and debt securities. Please recommend the best route to follow.

Like several people of the previous generation, your parents are more comfortable with traditional investment products, the ones that were widely available when they might have started investing. Awareness of the numerous newer and more efficient avenues for investment is also not widespread. The mutual fund industry itself is so vast that even experts may struggle to find the best funds; hence probably due to a bad experience they may be cautioning you. But a well chosen mutual fund will result in a happy investor in the long run.

Fixed deposits are fine in terms of safety, but they are tax-inefficient. FMPs are a better substitute for FDs; they are low-risk investments, give better returns, and are tax-efficient. Also, alternatives like open-ended debt mutual funds and tax-free bonds generally give better post tax returns than FDs. Note that the debt mutual fund and FMP must be held for three years to be more tax-efficient than FDs. Taxes and returns from FMPs and FDs for a period less than three years are similar.

Coming to endowment or money back policies, these are not a preferred investment avenue in my view, since its returns are only slightly higher than savings bank accounts, in some cases even lower. The various charges deducted from the premiums in insurance policies are detrimental to the return on investment. As I have already mentioned in my previous article, insurance products should not be treated as investments. The value that comes from an endowment policy is far less than that of investing in a combination of a traditional term plan and another investment avenue like mutual funds.

PPF is a good investment product with safety since it is backed by government securities. The current post tax return of 8.7 per cent is amongst the highest with this level of safety. And as a tax saving mechanism, full advantage of the 80C clause should be taken. Considering your age you can consider investing in a combination of PPF and equity-linked savings schemes to take advantage of the Rs 1.5 lakh limit under Section 80C. ELSS funds have a three-year lock-in and PPF comes with a lock-in period of 15 years. The returns from a good ELSS are comparable to the best-of-breed open-ended equity schemes. ELSS funds may be invested in through an SIP.

The table below illustrates the historical performance of equity and debt mutual funds over the last five years. Please note that the past performance is for illustration only. The past performance may or may not be sustained in the future and the same may not necessarily provide the basis for comparison with other investments.

It is suggested that you follow an investment style which suits your risk profile and needs rather than following one which was followed by your parents as several changes since then have made it a much more investor-friendly environment. These include:

• Numerous financial instruments available.

• Transparency in products and companies.

• New tax rules that encourage savings and investments.

• A developing and growing economy.

• Equity markets and the mutual fund industry are well-regulated and secure the interests of the investor.

When you are starting off, it is best to have a strong portfolio with a mix of equity and debt mutual funds, based on your risk profile and time horizon. Investing in equity at an early age such as yours is very beneficial as the magic of compounding starts much earlier. Therefore you could go heavier on the equity portion if you don’t require the money soon. It’s always suggestible that invest according to your risk profile, where a financial advisor will help you in that.