Investment Objectives & Advice

Retirement Planning 4.0: Core & Satellite Portfolio Investing

Last post on the Path of financial freedom (Investment required calculator: Link) triggered the question by many about how their portfolio should be? Most of them take high risk synonymous to higher returns and build portfolio heavy on Small/Mid-cap funds etc. Though building a core portfolio is like building your physique. You do not join gym and do only biceps or squats alone, It has to start with strengthening the core and then build the holistic physique. Similarly While exercising with heavy weights you need to protect your core by using the waist belts etc, same way you need to protect your core portfolio as well from sudden risks.

Core & Satallite Portfolio

How to build core portfolio?

Core portfolio should be followed with discipline of investing regularly and should have limited volatility with sufficient growth to beat inflation and should not be tapped into unless extremely critical. This will provide you the stability needed to build sustained wealth over time. This is given with healthy mix of Debt and Equity.

For employed people, Employee Provident Fund (EPF) is a great investment avenue and still least talked about. It gives good stable returns as well as disciplined investing of 12% of basic salary (additional 12% added by employer). The 24% of basic salary is getting invested automatically as well as for long term build a great corpus together. If you are not not employed, you can chose options like PPFs, Sukanya Samridi, FDs or Debt Mutual funds etc. (To know how to build your debt portfolio: Link)

On the strength of the Debt portfolio, you should top it up with equity investments of similar amount to help you beat the inflation by good margin. My suggestion will be to Large-cap mutual funds or Index funds/ ETFs. Though if you are risk averse you can use a Hybrid Equity/ Balanced advantage fund and if you are aggressive, you can opt for multi-cap funds. In any scenario, you should not get Mid or small cap funds in core portfolio.

How much money to invest in your core portfolio?

For employed people roughly 45-50% of the basic salary or you can check the amount required for your financial freedom. If you are self employed or a business person, you should aim to invest 30-40% of the net monthly income (Monthly Income – EMIs/House rent – insurance premiums) into core portfolio.

How to protect your core portfolio?

Your core portfolio is not only to provide for your retirement years but also to take care of your dependents.  There are two main risks to your core portfolio, health risk and mortality risk. Most of us feel uncomfortable buying health or pure term plans as in case of no event the premium paid is lost. We do not feel the same for buying the bike/car insurance as it is mandatory. We should consider the health and pure term cover as mandatory only for healthy and happy life.

This basic construction of portfolio will help you get a great foundation to build your overall wealth. (Check the Portfolio built using Cor portfolio: Link) If and when you can save more, then only you should create satellites in your portfolio in form of Small, Mid-caps, Direct Stocks, Futures & options, PMS, real estate, gold and other options.

Happy Investing!

Mutual Fund

How to build your Debt Mutual fund portfolio?

Let us start with understanding of step 1, Should you invest in a debt fund portfolio?

In a global wealth study for 2017 by BCG, One thing that stands out was the portfolio composition of investors in Asia vs Investors in North America. Asian tend to have 65% of their investments in Cash & deposits vs 14% investment by North American and the figures are reversed for Equity investments 70% for North American vs 23% for Asia. This is due to two main reasons, one is the availability/ reach of debt products in markets in form of deposits by banks & post offices and second is our inherent nature to look for stable and assured returns. If you will collate all your investments, you will be surprised to know that it is true for you that >70-75% of your investments are in Debt products (Savings account, Fixed Deposits, Recurring Deposits, Monthly Saving Schemes, Tax Saving FDs, NSCs, Money back or Endowment Insurance plans, Public Provident Fund, Employee Provident Fund, Sukanya Samridhi Scheme, Senior citizen saving scheme etc.).

Few of these products are really very optimal and suitable to invest in terms of their return and risk profile: Public Provident Fund, Employee Provident Fund, Sukanya Samridhi Scheme, Senior citizen saving scheme, PM Vyay Vandan Yojna. All these have certain limitations as well.

  1. Except PPF, not everyone can invest in the other schemes unless they fulfill the required criteria
  2. Liquidity of these investments is limited and restricted by its own clauses

if you can not invest in these options and you fall in tax bracket of >20% tax then best place to get reasonable stable returns are in form of Debt Mutual Funds. Also, If you are Liquidity freak like me then you can also leverage the Debt Mutual Funds along with above options. No need to read further if you do not fall in any of the above two category.

Are there any risk in Debt Mutual Funds?

Nothing comes for free, If Debt Mutual Funds provide you option to get better return and liquidity, It also exposes you to interest rate and counter party risks.

  • Interest rate risk: Debt Mutual Funds do not provide predefined returns for the agreed investment horizon like Fixed Deposits. With the change in market driven interest rates, the return of the Debt Mutual Fund changes. If interest rates goes up, the return decreases and vice-versa. The change in return depends on the duration of bonds the fund is holding, means the fund holding 10year maturity bond will see higher change in returns vs fund holding 15 days treasury note. You can see from the below chart that Long duration funds are giving lower 1-year returns vs Liquid funds.

Bond Fund Returns

  • Counter Party Risk: When the company issuing bonds default on it’s payment of interest or principal due, this is called counter party risk. Government bonds (Gilt’s) are considered to be free from such risk but Corporate bonds do have such risks, which can be mitigated by buying the bonds of only highly rated corporate or can be reduced by diversifying your investment across multiple companies so that default by one should not hamper your portfolio drastically

Which Debt Mutual Fund should i buy?

Chart shows you the recent categories of Debt MFs as per latest SEBI guidelines. When you want to invest for shorter time horizon you should move towards extreme right (Liquid Funds). Investing for decently large emergency corpus or parking money for short time frame should stay in those categories as the mean returns are stable across 1,3 or 5 year periods as well as the Std deviation is smallest for this category.

If you want to invest to get better returns over medium term of 3-5 years period, you can use Medium term plans or Corporate bond funds. People looking to invest for long time horizons for retirement or specific goals like child’s education or marriage can also leverage gilt funds, opportunistically.

Read more on Mutual funds, Retirement Planning.

Please speak to your investment adviser to check the funds suitability for your risk and portfolio requirement.