The stock market is at a lifetime high - should you buy, sell or hold?

A TV anchor was interviewing a fund manager when the market started to correct after touching a new high. The following is a brief excerpt of the Q&A session:

Q: You are holding 16% in cash. Is it because you are expecting a big correction in the market?

A: It's not like that. We hold a basket of stocks and have price targets for each stock. When a target is hit, we book profits.

Q: You mean several stocks have hit their targets during the recent rally - that is why you have excess cash? Why are you not redeploying in other stocks?

A: It is difficult to find new ideas near a market top, as everything appears overvalued. So, we have invested in money market instruments.

This is a classic problem that fund managers face. They can't afford to hold large amounts of cash because it affects fund performance. But they are wary of redeploying at high valuations in case the market turns against them.

Small investors with a long-term outlook need not be bothered by such a problem - provided they have a proper asset allocation plan.

The asset allocation plan will determine the investment strategy. How?

Let us look at an example - a plan with 70% in equity shares, 25% in fixed income instruments and 5% in cash. That means, out of a monthly saving of Rs 10000, Rs 7000 is being invested in an equity fund, Rs 2500 in a debt fund and Rs 500 in a liquid fund.

After a year, the invested amounts are Rs 84000 in the equity fund, Rs 30000 in the debt fund and Rs 6000 in the liquid fund. 

Due to the bull rally, the NAV of the equity fund has gone up 20% - so the amount in the equity fund has increased to Rs 100800. The amount in the debt fund has increased to Rs 31500 (say), and the amount in the liquid fund is Rs 6500.

The asset allocation has now changed (due to the rally) to 73% in equity fund, 22.5% in debt fund and 4.5% in liquid fund.

You now have three options: 
(i) book partial profits in equity fund and redeploy in debt and liquid funds to restore the original allocation and continue with your monthly SIPs; 
(ii) restore the original allocation by adjusting your monthly SIPs by investing less in equity fund and more in debt and liquid funds; 
(iii) continue with your monthly SIPs and ride the bull rally a little longer - allowing the equity allocation to rise to 75% before choosing options (i) or (ii).

From the point of view of simplicity, option (i) is the least complicated. The reallocation is suggested after one year to avoid paying any long-term capital gains tax on your equity fund profits.

What about the answer to the question? As was mentioned earlier - you have no need for it.

A simple Strategy to achieve your Financial goals

(When Paul McCartney wrote the words "I don't care too much for money, 'cause money can't buy me love" he probably didn't have enough of it!)

There are three ways of making money:

1. Work hard
2. Own assets that earn money
3. Work hard and own assets that earn money

Unless you are born with a silver spoon in your mouth, you can't start adult life with option 2. So, you have no option but to work hard - whether at a job, or a business.

What you do with the money you earn by working hard will determine whether you will achieve your financial goals and will be able to retire later in life to benefit from option 2.

The simple strategy to achieve your financial goals? Save and invest. And the sooner you start, the better.

But you knew that already - right? 

Do you also know how much money you will need to save today, and what mix of assets you need to invest in so that when you eventually stop working you will be able to live comfortably on what your assets will earn?

Probably not - as per anecdotal evidence from a few young working people. 

One complained she hardly has any savings left after paying for rent, food and the daily commute. Another said he is putting some money into a mutual fund every month, but hasn't figured out how much he will need 30 years from now.

Would it be a surprise to know that both own high-end smartphones and laptops, commute only by app-cabs, wear designer clothes, eat out 2-3 times a week and rent apartments in posh localities?

Living the good life now may mean that you will neither be able to retire early to do the things you really love, nor will you be able to enjoy retired life without cutting corners. 

Is there a way to live reasonably well now - and in future when you will not be able (or willing) to work any more?

There is - but you will need to plan for it:

- Set financial goals - near-term, medium-term and long-term
- Figure out how much money you will need at each stage
- Save and invest accordingly

For longer term goals, you can and should invest in riskier assets like equity or equity funds for better returns. For nearer term goals, invest in less risky assets like bank fixed deposit or debt funds.

From your monthly/quarterly earnings, invest first (according to your financial plan) and then spend. 

Stay a bit farther away from town, commute by autorickshaw or train, eat out only once or twice a month, buy a cheaper phone and laptop, pay off your credit card dues in full every month. 

You will be amazed how much these small sacrifices now can lead to a more comfortable retired life. (Believe it or not, you will get old and retired life will be upon you sooner than you expect!)

Does your Investment Style fit your Personality?

To be a successful investor, you must have your own investment style. That means evolving a system that works for you - by figuring out your own strengths and weaknesses and keeping a record of your successes and failures.

Every person has personality traits, cognitive biases, eccentricities, habits that affect their decision making. If you are impulsive, you may buy 5000 shares of Opto Circuits at Rs 9 and hope to double your investment in 3 months.

If you are risk averse, you may be happy with the long-term returns you get from a monthly SIP in an index fund or a balanced fund. 

An investor below the age of 30 may invest all her monthly savings into an equity fund. An investor who has already celebrated his 50th birthday may prefer the safety of bank fixed deposits or a debt fund.

According to an article published by the CFA Institute, there are four types of Investor Personalities:

1. Preservers - loss averse and deliberate in decision making, they are more keen to preserve their existing wealth than indulge in risky investments in search of rapid growth. They often end up not taking any decision at all and miss money-making opportunities.

2. Followers - not much interested or skilled in the investment process, they end up following the advice of friends or colleagues and have a portfolio full of yesterday's winners.

3. Accumulators - may have tasted success in a business enterprise or career, giving them the confidence to actively manage their own investment portfolio. They like to win big, and often make large risky bets that can lead to big losses.

4. Independents - like to think 'out of the box' and play contrarian based on their own research. They usually follow a plan and are not as over-confident as Accumulators. But relying too much on their own research can be time consuming and counter-productive.

So, which of these four Investor Personalities fit you the best? Give it some thought (if you haven't done so before) and then decide what kind of investment style you should follow. Your investment success will depend on it.

Read more from this investopedia.com article.  

How many Mutual Funds should you hold to adequately diversify your portfolio?

If you ask that question to your friendly fund agent, he may say: "The more the merrier. The more funds you have the more diversified will be your portfolio." From his point of view, the answer may seem logical. 

If you listen to his suggestion, you may end up with 15 or 20 funds. There are so many funds to choose from - large-cap funds, mid-cap funds, small-cap funds, multi-cap funds, FMCG funds, banking funds, infrastructure funds, arbitrage funds, funds of funds, balanced funds, ELSS funds, gilt funds, short-term debt funds, long-term debt funds, income funds, liquid funds, gold funds, and so on.

After a year, you will find that your portfolio has under-performed the fixed deposit rates of banks because the good performance of some of the funds have been neutralised by the poor performance of the others.

So, what should a small investor do? The answer is: It depends. On what? On where you are in your investing/wealth-building stage.

If you are a young person who has just joined employment, investing your meagre monthly salary savings in one good balanced fund may serve your purpose and provide adequate diversification. 

The equity component of a balanced fund can comprise a mix of large-cap and mid-cap stocks. The debt component can comprise a mix of government securities, company fixed deposits, NCDs. 

The equity component takes care of growth. The debt component minimises downside risk. A balanced fund with 60-65% equity component is treated as an equity fund. That means they are not subject to long-term capital gains tax and dividends paid are tax free. 

Someone who has been working for a while, or is running a successful small business, more substantial monthly savings may be available for investment. In which case, a large-cap equity fund, a mid-cap/small-cap fund, an ELSS tax saving fund, a gold fund and a debt fund should provide adequate diversification.

What about all the other types of funds mentioned earlier? Aren't there money-making opportunities in them? 

Yes, if you have nothing better to do than monitor the performance of your funds regularly. Then you will be in a position to move in and out of your funds to increase returns - most of which may be eaten away by fees and taxes.

No, if you want your funds portfolio to run on auto-pilot while you spend your time and energy in furthering your career or growing your business.

Many investment advisors - particularly the ones who work in wealth management divisions of private banks - are clueless about what constitutes an adequately diversified funds portfolio.

Typically, they give you a suggested list of funds that are 5-star or 4-star rated by valueresearchonline.com or moneycontrol.com and expect you to choose from them. 

You may end up with 8 or 10 funds all of which hold Infosys, Reliance, L&T, HDFC Bank, Tata Motors among their top holdings. In which case, the performance of all your funds may depend on the performance of just these 5 stocks - giving you hardly any diversification.

You will be better off just buying these 5 stocks and not buying any of the suggested funds.

Remember that the more funds you have, the more time you will need to spend in monitoring their performances. Also, proper fund selection to avoid duplication of holdings will give you better portfolio diversification.

Last, but not the least, avoid the newer funds. Choose established funds that have a long-term returns track records.

Add some stability to your stock portfolio with bonds/debentures

For the past few months, the stock market has been all over the place – rising 300 points one day and falling an equal amount a couple of days later. The end result of such gyrations have left Sensex and Nifty with negligible gains since Jan ‘15.

An investment portfolio that is overweight in stocks may have given zero or even negative returns. Though a stock market seldom moves in one direction – even during rampant bull or bear markets – periods of uncertainty and volatility often come as a jolt to small investors.

To ensure a less volatile and more stable investment returns, it is imperative that investors appreciate and understand the need for a proper asset allocation plan. That means, balancing your stock portfolio with fixed income instruments like bonds/debentures.

As per my interactions with many small investors, very few of them fully understand the benefit of bonds/debentures. To most small investors, fixed income instruments mean bank fixed deposit, or Post Office MIS, or NSC.

Debt oriented mutual funds and tax free bonds often provide better post-tax returns, and have the added advantage of being liquid. That means they are more easily tradable.

If you want to learn the ABCs of investing in bonds and how interest rates affect returns, check out a set of links to articles published in investopedia.com:

1) http://www.investopedia.com/articles/bonds/08/bond-market-basics.asp

2) http://www.investopedia.com/articles/bonds/08/credit-invest.asp

3) http://www.investopedia.com/articles/bonds/07/price_yield.asp

4) http://www.investopedia.com/articles/bonds/08/bond-risks.asp

Related Post

How to reallocate your assets

Nifty chart: a mid-week update (Jan 21 ‘15)

The unscheduled interest rate cut by RBI seems to have recharged the batteries of FIIs. Their buying spree over the last four trading sessions have turned them into net buyers of equity in Jan ‘15 from being net sellers. Not surprisingly, DIIs have turned net sellers. That could not prevent Nifty from soaring to a new lifetime high.

IMF has forecast that by 2016-17, India will be growing the fastest among major economies. The expected GDP growth of 6.5% is likely to outpace China’s expected GDP growth of 6.3%. A possible quantitative easing programme announcement by ECB will boost bullish sentiments further.

Q3 results declared so far have been uninspiring. Top and bottom line pressure is visible across sectors. There has been a noticeable shift by investors towards large-cap companies of late.

Nifty broke out upwards from the ‘symmetrical triangle’ pattern within which it was consolidating for the previous 6 weeks. The break out occurred with an upward ‘gap’ and an increase in volumes that provided technical validity to the break out.

Subsequent buying on good volumes propelled the index above its Dec 4 top of 8627 to new lifetime intra-day and closing highs. Nifty has again entered ‘blue sky’ territory with no known resistances.

All three EMAs are rising, and Nifty is trading well above them in a long-term bull market. The consolidation within the triangle provided a good opportunity to investors to reallocate and streamline their portfolios.

Daily technical indicators are looking bullish, but a bit overbought. MACD is rising above its signal line in positive territory. ROC has climbed sharply above its 10 day MA to enter overbought territory. RSI has moved up to the edge of its overbought zone. Slow stochastic is well inside its overbought zone.

Nifty may consolidate or correct a bit before continuing its up move. This is not the time to feel excited or to buy unknown ‘cheap’ stocks. That is a sure recipe for disaster.

With interest rates likely to come down further during this calendar year, investing a portion of your savings in long-term debt funds makes a lot of sense.

BSE Sensex and NSE Nifty 50 index chart patterns – Jan 02, 2015

Trading activity was at a low ebb during the first four days of the week, as most FIIs were on vacation due to Christmas and New Year holidays. There was a renewed spurt in activity on Friday as both FIIs and DIIs were net buyers of equity.

Good news came from HSBC’s Purchase Manager’s Index (PMI), which rose to a 2 years high of 54.4 in Dec ‘14 from 53.3 in Nov ‘14. A number higher than 50 indicates growth in industrial activity. Bad news was government’s fiscal deficit touching 99% of full year budget estimates during the first 8 months of the fiscal year.

An increase in excise duty on petrol and diesel to fund infrastructure development programmes should come as welcome news for construction, cement and steel sectors. Withdrawal of excise sops was not-so-welcome news for the automobile sector.

BSE Sensex index chart

The daily bar chart pattern of Sensex traded sideways within a narrow range till Thu. Jan 1 – facing strong resistance from its entangled 20 day and 50 day EMAs. An upward break out occurred on Friday on renewed buying by FIIs.

Daily technical indicators have turned bullish. MACD is still negative, but has crossed above its signal line (which is forming a ‘rounding bottom’ pattern). ROC is positive, and above its 10 day MA (which has formed a bullish ‘rounding bottom’ pattern). RSI has risen above its 50% level. Slow stochastic has just entered its overbought zone.

The support/resistance zone between 26300 and 27350 provided good support to the index during the recent correction. Expect the up move from the Dec ‘14 low of 26469 to continue.

NSE Nifty 50 index chart

The weekly bar chart pattern of Nifty received strong support from its 20 week EMA and the support/resistance zone between 7840 and 8180, and closed at 8395 – its highest level in 4 weeks. The index is trading above its two weekly EMAs and the dark blue up trend line 2 in a long-term bull market.

Weekly technical indicators are turning bullish. MACD is below its signal line in positive zone, but has stopped falling. ROC is also positive, and has received support from its gradually rising 10 week MA. RSI and Slow stochastic have bounced up after receiving support from their respective 50% levels.

Look for an increase in volumes as Nifty continues with its up move next week. Otherwise, the rally may not sustain.

Bottomline? Chart patterns of BSE Sensex and NSE Nifty indices have recovered from sharp bull market corrections. Long-term up trends are intact. Both indices should resume the next legs of their bull rallies with buying support from FIIs. If you have booked profits, think about redeployment in long-term debt funds – which should do well with likely reduction in interest rates.

(Note: A limited number of paid subscriptions to my Monthly Investment Newsletter are being offered to blog visitors, followers and subscribers. Offer ends on Jan 21, 2015. Contact me at mobugobu@yahoo.com for details.)

What to do when the stock market is bearish and volatile?

When stock markets are bearish and volatile, small investors feel anxious and unsure of what to do. Activity, innovation and endeavour are useful in business and employment – but they detract from wealth building. One has to be passive, dispassionate and patient to be able to make correct investment decisions when there is chaos and bad news flying around.

Having a financial plan with clear goals, and an asset allocation plan to meet those goals, helps investors to remain calm and resolute under adverse conditions. A proper asset allocation plan should include an equity component, a fixed income/debt component, a small allocation to gold and some cash. If you don’t have a plan yet, the time to start is now.

The equity component can comprise equity funds, balanced funds, index funds, sectoral funds, company stocks or any combination of these – depending on an investors risk tolerance and investing skills. The debt component can comprise PPF, Post Office MIS and other small savings schemes, bank fixed deposits, debt funds or any combination of these – depending on an investor’s risk tolerance and tax bracket.

The importance of the tax bracket should be remembered in choosing the constituents of the debt component. PPF (Public Provident Fund) scheme is available at post offices and banks. It allows an investment of a minimum of Rs 500 upto a maximum of Rs 1 Lakh per year. The entire investment is tax free under Section 80(C) of the Income Tax act. The dividends (around 8.5% per annum) are also tax free. For small investors, it makes sense to utilise the PPF avenue to the limit. The holding period is 15 years – which allows compound interest to work its miracle. Part withdrawals are permitted after 5 years. Investment can be extended beyond 15 years.

Interest on Post Office small savings schemes (7-8% per annum) and bank fixed deposits (8-9% per annum) are taxable. The tax will depend on an individual’s tax bracket. Rs 9000 earned on a Rs 1 Lakh bank fixed deposit will entail a tax of Rs 900/1800/2700 for tax bracket of 10/20/30%. So, the effective return will be 8.1/7.2/6.3% after tax instead of 9%.

For those in the highest tax bracket, and even for others, investment in debt funds – particularly gilt funds – is advisable. Gilt funds mainly invest in government securities, so there is negligible chance of shrinkage in the principle amount invested. Dividends are not taxable in the hands of investors, but the funds pay a dividend tax. Tax is payable at the time of withdrawal and is treated as short-term (for holdings of 1 year or less) or long-term (for holdings beyond 1 year) capital gains tax. Indexation is allowed for long-term capital gains, which can be a great advantage for long period of holding.

Another benefit of a gilt fund over a Post Office/bank fixed deposit is that you can add to or withdraw from your holdings at any time. A couple of gilt funds – IDFC GSF PF regular and Kotak Gilt Investment regular, which gave 12.5% and 14.2% returns over the past 12 months – beat fixed deposit returns comfortably. They may not do so in future, but the Kotak fund has given 10.35% returns since its launch in Dec 1998.

The importance of an asset allocation plan can’t be emphasised more. The most common query received from investors is: “Is this a good time to start buying?” The answer should be provided by the individual investor’s asset allocation plan – not by me!

What if the stock market remains in a down trend for another year?

The Sensex and Nifty indices had touched their peaks one year back. Since then, both indices have been in down trends – neither falling a lot, nor rising much during counter-trend rallies. A gradual drift downwards that has all but sapped the bullish energy of small investors.

Several rounds of interest rate hikes by the RBI have failed to restrain rising inflation, but has started affecting economic growth. The high interest rates have led to postponing or cancelling of capital expenditure by companies, which in turn has affected the order books of capital goods makers, and engineering and construction companies.

The RBI had indicated the possibility of pausing the rate hikes if inflation begins to moderate. If the situation doesn’t improve within the next month or so, the RBI may be forced to hike the interest rate again.

Even if there is a pause in the rate hike, the already high rates are unlikely to be reduced immediately. Market sentiments do not turn bullish when interest rates are high and the GDP growth is slipping. It is quite possible that the Sensex and the Nifty may continue to trend downwards for another year.

However unlikely or pessimistic the above may sound, the path to success in stock market investing is to assess the surrounding environment at all times, and have strategies and plans in place. So, what can small investors do to prepare for another year of down trend in the stock indices?

The most important – and I can’t emphasise this more – is to have a financial plan, and based on it, an asset allocation plan. The queries I receive from small investors are mostly of these two types: “This stock is going up in a bear market – should I buy now or wait” or, “That stock has fallen a lot – should I wait longer or buy now”.

Hardly anyone asks me: “How do I make a financial plan” or, “How do I work out an asset allocation plan”. Without a plan, random buying and selling of stocks will lead to an unwieldy portfolio and very little returns.

Once plans are in place, a portfolio to suit the plans and the risk tolerance level of an individual can be built. A stock market in a down trend is the best time to build portfolios, because many good stocks are available at bargain prices.

What if you are one of those enlightened investors who already has plans and a well thought-out portfolio in place? Allow your portfolio to grow and prosper. How do you do that in a down trend? Mostly by not being overly aggressive. Within an overall down trend, individual stocks may perform better or worse. Use opportunities to book part profits or add to fundamentally strong stocks that have been beaten down.

Needless to say, whether to buy, sell or hold should be determined not by market fluctuations or gut feel, but by your asset allocation plan. When you book part profits, try to control the impulse of buying some thing right away. The high interest regime has its benefits in the form of higher bank fixed deposit rates and good returns from debt funds. Invest in them – as per your asset allocation plan.

Use the stock dividends that you receive at this time of the year to reinvest in your portfolio companies. Dividend reinvestment is like adding fertiliser to your plants. It helps them to grow better and faster.

Continue with your regular savings and systematic investment plans. There is a tendency of many small investors to stop investing when the markets are down. If you haven’t developed the skills to time the market (very few investors do), stick to your regular investments. Again, follow your asset allocation plan in a disciplined manner.

That is all there is to it. No magic formula will produce phenomenal returns in a down trending market. Just a boring, disciplined approach to planning, saving and investing for building wealth over the long term.

About Asset Allocation – a guest post

Many small investors jump into the market – usually near bull market peaks – without doing any prior homework about how the stock market or mutual funds industry operates. They end up with a portfolio full of questionable investments that teaches them a very costly lesson – there are no short cuts in life, and definitely not in the field of investments.

Now that the stock market is hovering near its all-time peak, Nishit’s guest post addresses the important concept of asset allocation. Investing without an asset allocation plan is like going to a railway station and hopping on to the first train that is leaving a platform without knowing where it is headed. You may get somewhere, but it may not be a place you want to visit.

The thrill of adventure of not knowing where you are going – physically or financially – may be fun for a while, but expensive in the long run. Following an asset allocation plan takes away most of the uncertainty of your investment future, and ensures that you stay invested through the ups and downs of the market.

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Today, we explore an important pillar of financial investing: asset allocation. Before we move further, let me ask you one of the most fundamental questions: Why do we work for a living? Why do we spend stressful hours commuting, tolerating unpleasant bosses, enduring long caffeine-fuelled meetings? Do we do it because we like doing it? Some of us may love our work greatly, but for most it is a way of earning money. The path to an early retirement is proper asset allocation.

Assets are of various types. They could be equity, debt, real estate, gold, and cash. The idea is to earn an optimum rate of return by taking the right amount of risk. The risk profile of every person is different. Riskier assets generally yield more returns, but not everyone can take the same amount of risk. A person aged 30, having a good job can withstand some capital erosion but a retiree at 65 with no avenues of earning money other than those generated from his assets can’t afford to lose money.

A thumb rule of asset allocation is that a person can invest upto (100 - age)% in equity. For example, a 30 year old can have 70% asset allocation to equity while a person who is 65 years old should avoid investing more than (100 - 65 =) 35% in equity. Now, thumb rules are meant to be only a guideline.

While making an asset allocation plan, one must also look at the ease of liquidation of the assets. How many days would it take to liquidate the assets and have hard cash in hand? Equities and gold ETFs normally take 3 days from the date of selling to get cash in hand. Debt can usually be redeemed in about a week’s time, be it mutual funds or fixed deposits – sometimes with a penalty of 1-2%.

The trickiest asset is real estate. It requires legal documentation, involves part transaction in ‘black’ money and has almost no transparency. Also, when the prices start falling you may find no buyers. I am a strong advocate of the policy of owning only the house you live in. Else, invest in REITs or stocks of real estate companies.

The trick is to treat all your assets as a fund and find out what the rate of return on the portfolio is. Any return above 16% (twice the 10 year government bond rate) is an excellent return on investment. The idea is to get rich slowly, step by step.

The cardinal rule to be followed is preservation of capital, followed by return on investment. For a 30 year old, the portfolio could be 20% gold, 40% equity and 40% fixed income. For a 60 year old the equity could be 20%, rest in gold and debt.

An example of retiring early and doing what one wants is Lakshmi Ramchandran, who blogs at http://vipreetinvestments.blogspot.com/. She took Voluntary Retirement from her bank in 2001 and is doing what she loves most. She does Technical Analysis, trades the market and enjoys life at her own pace.

Further insights on asset allocation can be found here: http://www.investopedia.com/articles/pf/05/061505.asp

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

Related Post

How to reallocate your assets

Debt mutual funds or Bank fixed deposits - which is better?

In a recent post, I had briefly mentioned that I prefer bank fixed deposits over debt mutual funds because of the assured returns. Reader Eswar joined issue with me, stating that he preferred debt mutual funds for the convenience of easy liquidity and on-line transactions.

Eswar's point of view made me take a closer look at debt mutual funds to assess the pros and cons vis-a-vis fixed deposits in banks.

Bank fixed deposits (FDs) are amounts kept for specific periods in a bank with a pre-fixed rate of return. The return varies on the time periods, and from bank to bank. Interest payments can be cumulative and paid at the time of maturity, or in monthly or quarterly installments. Many banks calculate the interest accrued on a quarterly basis - hence quarterly interest payment is preferable to monthly payment.

Debt mutual funds (often called income funds) invest more than 50% of their portfolio in corporate debentures, bonds, gilts, treasury bills, bank fixed deposits and commercial papers.  Dividends can be paid out quarterly or monthly (in certain schemes), or reinvested in additional units. The growth option works much like cumulative interest in fixed deposits.

There are four points of departure. Let us look at them one by one:-

1. Interest payments are assured and the principal amount is more secure for a bank FD. There is no assurance of dividend payments or protection of capital for debt mutual funds (MFs).

2. Bank interest is taxable in the hand of the depositor. Dividend payment on debt MFs are tax free in the hand of the depositor, but subject to a dividend distribution tax payment by the MF prior to disbursement of dividend.

3. As on date, bank FDs carry an interest rate of 8-8.25% (with an additional 0.5% interest for senior citizens). Medium term debt MFs have typically given a return of 7-9%. With the security of assured returns and principal protection, investing in bank FD should be a no-brainer at current interest rates. Things change when you calculate the real rate of return after tax.

Those who are in the lower tax brackets may get a slightly better post tax return in a bank FD. But if you are in the highest tax bracket, then debt MFs can provide slightly better post tax returns.

4, If an investor has a sudden requirement for liquidity, a bank FD can be 'broken' (i.e. terminated before the stipulated period) with a penalty of 1% interest. The effective interest will become 7-7.25% at current rates.

For debt MFs, there may be an exit load (of 1%) for redeeming the units prior to 6 months or 1 year from the date of allotment. In case of appreciation in unit NAV (net asset value) at the time of redemption, short term/long term capital gains tax will apply.

So, to answer the question, it depends entirely on the asset allocation plan and risk tolerance of individuals. For older, risk averse investors, bank FDs are still the investment of choice. Younger investors with higher risk tolerance may opt for debt MFs.

A Correction and some Observations about Mutual Funds and ETFs

About index funds and ETFs

This discussion is not about the correction that has been seen in global stock markets this week. In an article about two index funds, I had discussed about ICICI Pru Index Fund Retail and UTI Sunder. My broker pointed out that UTI Sunder is not an index fund but an index ETF. That means you require a demat account to purchase or sell units of the fund. The oversight is regretted.

Index ETFs are supposed to track the index closely. But due to the very low volume of transactions in the UTI Sunder ETF, unit prices move abnormally higher or lower even on small transactions. Investors may be better off with Nifty BeES, which tracks the Nifty more closely and has decent volume of transactions as well.

About SIPs

I often receive queries about SIP (Systematic Investment Plans) in mutual funds. My bias against SIP has been documented in this post. However, SIP works if used during sideways consolidation patterns - like the one we had in the Sensex for the past 6 months.

If you have the self-discipline, then keep the investment date flexible. Signing up for a SIP plan with a mutual fund every month or every quarter locks you into specific dates. You won't be able to take advantage if there are sharp market turns in between.

About Debt MFs

Some times investors ask me if they should put money into a debt mutual fund instead of a fixed deposit. I am old fashioned and have never invested in debt MFs. I like the assured return in a FD, even though the return is taxable. A quarterly interest payout from FDs provide a regular cash inflow - which a debt MF may not be able to match.

About Sector Funds

These are more risky and volatile than diversified equity funds. Unless you have a very good reason, avoid sector funds. There were a plethora of infrastructure fund offerings during the bull market. Many performed spectacularly. But their fall has been equally dramatic.

The only exception would be if you really know every thing about a sector, let's say the banking sector, that needs to be known but do not have sufficient cash to deploy in more than one stock. In that case, an investment in a banking sector fund may work for you.

About Gold ETFs

Buying and storing of gold - whether bars or coins or jewellery - has been a tradition with many Indian families. With the advent of gold ETFs, the hassle and risks in storing physical gold can be avoided.

According to some gold analysts, the bull period in gold has not ended. It is about to get even bigger and stronger. I've never bought gold or gold ETFs. But with the current uncertainty in the global economy, a small investment - not more than 5% of total investment portfolio - may not be such a bad idea. I'm looking at UTI's gold ETF for possible purchase.

If any reader has a better idea, I'd be more than happy to hear from you.