Strategies for Building a Balanced Bond Portfolio
With
growing levels of financial literacy, the investment scenario in
post-liberalisation India has improved many folds in the past three decades.
However, a lot needs to be done to address the complacency that characterises
the populace’s investment decisions. While the rise in financial literacy has
undoubtedly empowered investors, there remains a significant challenge:
complacency. Despite access to a myriad of investment options, many individuals
fixate on familiar products, neglecting the need for strategic and a balanced
portfolio construction. This tendency holds true across categories of
investors, including investors primarily dealing in bond products.
The decision to invest in bonds is generally determined by the obvious benefits – risk-adjusted total returns, stable regular income in the form of interest payments, tax benefits and the like. However, many investors do not pay enough attention towards the idea of curating bond portfolios in a way that can help them make the most of these benefits, while also considering their individual advantages and limitations. So, as far as strategy is concerned, is there a good framework investors can rely upon while arranging their bond portfolios?
Vital Festures of a Balanced Portfolio
Regardless of the specificities that characterise your financial position and goals, there are certain general mantras that are bound to greatly enhance the curation of your bond portfolio:
Diversification: Building Resilience
An ideal bond portfolio would involve a healthy quotient of diversification affiliated with different categories of bond products. Across times and regions, this advice has aged well. For instance, while it is true that over 75% of the bond products in the market are constituted by government bonds, it is still ideal to leave space for corporate bonds, municipal bonds, and the like. Keeping in mind the differential effects that macroeconomic changes can have on these products, in totality, such a strategy considerably aids your ability to hedge, while also managing your risk profile and ensuring efficiency. Similarly, the principle of diversification can also guide you in sorting through high-risk and low-risk bonds, thereby helping arrive at a risk-adjusted bond portfolio.
Find Common Ground Between Your Risk Capacity & Your Goals
Probably the most harmful characteristic of a complacent investment decision is that investors tend to not properly gauge their risk-taking abilities and devote less importance to the future. As a consequence, at the time of realising a particular product’s benefits after the investment matures, one feels underwhelmed and dissatisfied. Thus, it is important to understand that the value behind an investment is informed by one’s specific needs, financial position, risk-taking capability and future wants.
If you’re an investor who requires a healthy stream of regular income with a low threshold for risk, you can opt for the immunisation strategy, which allows you to choose products that reasonably cancel out the ebbs and flows concerned with interest rates, thereby helping you achieve your goal. At the same time, like most investors, if you also intend to reign in your long-term needs through your investments, it is recommended to devote a portion of your portfolio to products that will help you maximise your yields through a buy-and-hold strategy, also referred to as passive strategy, while also aligning reasonably with your risk profile.
On the other hand, if you're an investor with a high-risk profile who is concerned with maximising the total gains derived from a bond product, then opting for what's known as active strategy is sufficiently viable. The said strategy involves predicting future outcomes like anticipating future interest rates, analysing the possibility of future scalability and tracking the fundamentals of the firm selling the concerned set of bond products.
While devising a strategy to build your bond portfolio, it is important to consider these strategies and pick the combination that best suits your individual needs.
Investment Horizon: Planning for the Future
In addition to what has already been reeled off, your bond portfolio-building strategy should deeply consider the investment horizon you're comfortable with as an investor. The said investment horizon itself is ideally determined by one's future needs & plans, and the timelines associated with it.
For example, if you plan to be able to realise a certain amount of money by the time you retire, it is advisable to calculate the years left for the time to arrive and to opt for a product in accordance with the said period of maturity and the required total returns. On the other hand, if you plan to be a recipient of stable regular income after retirement, you’d benefit from bond products that focus on risk-adjusted interest payments.
The laddering technique, which allocates portions of the investable amount into different parts and products while considering the preferred maturity dates and income expectations at different intervals, can greatly aid us in deciding upon and navigating through our investment horizons.
Consider Tax Implications Associated With Your Preferred Bond Products
Though taxes do not feature high up in the list of priorities for many investors, it is crucial to understand that any holistic approach towards investment would require us to make room for tax considerations while building our bond portfolios.
Since tax rules concerning bond investments in India revolve largely around the period we decide to hold our gains for, factoring in this aspect can help us tailor our investment horizons and exit strategies as per our financial particulars, thereby helping manage our income levels and optimising the taxes we must pay.
Conclusion
All in all, building a robust and balanced bond portfolio requires us to be ever-more present while making our investment decisions. Indeed, positively considering the delineated factors and ditching complacency for a more attentive approach can greatly enhance the curation of one's bond portfolios.
Disclaimer: The contents of this article should not be construed as tax or financial advice. Readers should seek advice from their tax or financial advisor before making any investment decision.