Fixed income and debt investing are often seen as safe havens for risk-averse investors. Bonds, fixed deposits, and other debt instruments provide stability and predictability, which makes them attractive to conservative investors. However, while these investments are generally less volatile than stocks, they are not completely risk-free. Are you wondering if fixed income or debt investing is completely safe? Let’s reconsider.
In this article, we will examine the ten most popular debt investments in India and explore their associated risks. Based on their historical performance and potential risks, we’ve crafted a PlanB Risk Ranking to help you better understand where these instruments stand regarding safety and returns.
Why Debt Instruments Are Gaining Popularity in India
In India, debt instruments are commonly used by investors seeking steady returns and lower risk as compared to equities. The risk-averse investor often prefers these options, particularly in a volatile market. However, many debt instruments carry specific risks like interest rate risk, credit risk, liquidity risk, and inflation risk; that can affect returns.
With inflation eroding the purchasing power of fixed returns and the Reserve Bank of India (RBI) frequently changing interest rates, it’s important to reconsider just how “safe” debt investing is. We’ve ranked ten popular debt instruments, from the least risky to the more risky, to provide clarity on what investors can expect in terms of both returns and potential pitfalls.
10. Government Savings Bonds (G-Secs)
Risk Rank: 1/10 (Least Risk)
Government Savings Bonds or Government Securities (G-Secs) are often considered one of the safest debt instruments in India because they are backed by the government. These bonds offer fixed returns over a specified period and are low-risk. The returns from G-Secs have been stable over the years, with the 10-year G-Sec offering a return of around 6.2% annually over the past decade.
Key Risks: While the default risk is negligible, G-Secs are subject to interest rate risk. When interest rates rise, the market value of these bonds can fall, making them less attractive for secondary market investors.
9. Fixed Deposits (FDs)
Risk Rank: 2/10
Fixed Deposits are one of the most popular debt instruments in India. They are offered by banks and financial institutions and provide a fixed rate of return over a predetermined period. Over the last 10 years, the average return on FD has been around 6-7%, depending on the bank and tenure.
Key Risks: FDs are relatively safe but are susceptible to interest rate risk, especially when rates fall. They also have liquidity risk since funds are locked in for a specific term. Additionally, returns from FDs are taxable, which can eat into your profits.
8. Public Provident Fund (PPF)
Risk Rank: 3/10
PPF is a long-term government-backed savings scheme that offers tax benefits under Section 80C. It has a fixed interest rate, currently around 7.1% per annum (subject to change), and offers the benefit of tax-free returns. Over the past decade, the PPF has given stable returns, making it a safe investment for long-term goals.
Key Risks: The primary risk here is related to changes in interest rates, which can affect returns. Also, since the PPF has a lock-in period of 15 years, it can be less liquid compared to other options.
7. National Savings Certificates (NSC)
Risk Rank: 4/10
NSCs are another government-backed savings instrument, offering fixed returns with a tenure of 5 or 10 years. With returns of around 6.8%-7.0% over the past 10 years, NSCs offer stability and tax benefits.
Key Risks: While NSCs are safe from a default perspective, they do carry interest rate risk and liquidity risk, as the funds are locked in for a fixed period.
6. Corporate Bonds (AAA-rated)
Risk Rank: 5/10
Corporate bonds issued by highly rated companies, such as those rated AAA, offer higher returns compared to government bonds. Over the past decade, AAA-rated corporate bonds have offered returns between 7-9%, depending on the issuer and the economic cycle.
Key Risks: While they are considered low-risk due to the high credit rating, corporate bonds are still exposed to credit risk, particularly in economic downturns when companies might struggle to meet their obligations. They also carry interest rate risk.
5. Tax-free Bonds
Risk Rank: 6/10
Tax-free bonds, issued by government-owned corporations like NTPC, Indian Railways, and REC, offer tax-free returns to investors. Over the past 10 years, the average return from tax-free bonds has been around 6.5%-7%. These bonds are a popular choice for investors in the higher income tax brackets.
Key Risks: While they are tax-efficient, tax-free bonds still face interest rate risk, especially if RBI hikes rates. The market value of these bonds can fluctuate, but they remain a safe bet in terms of default risk.
4. Debt Mutual Funds (Gilt Funds)
Risk Rank: 7/10
Gilt Funds invest primarily in government securities and offer better returns than traditional fixed deposits. Over the past decade, these funds have yielded an average annual return of around 7.2%-7.5%. These funds are good for investors seeking a stable option but with slightly higher returns.
Key Risks: Gilt funds are subject to interest rate risk. When rates rise, the value of the bonds in the fund may fall. They are also subject to market volatility, although the risk is lower compared to equity funds.
3. Short-term Debt Funds
Risk Rank: 8/10
Short-term debt funds invest in securities with shorter maturities (less than 3 years) and offer relatively better returns than FDs. The average returns for these funds over the past 10 years have been around 8% annually.
Key Risks: These funds are less risky compared to long-term debt funds but are still subject to interest rate risk and liquidity risk. The performance of short-term funds can also be impacted by credit risk, particularly in a rising interest rate environment.
2. Long-term Debt Funds
Risk Rank: 9/10
Long-term debt funds invest in securities with longer maturities and are more sensitive to interest rate changes. Over the past decade, long-term debt funds have delivered average returns of around 9%-10% annually.
Key Risks: These funds face significant interest rate risk, as the value of long-term bonds is more sensitive to rate changes. There is also the potential for credit risk if the underlying bonds experience downgrades.
1. Credit Risk Funds
Risk Rank: 10/10 (Most Risk)
Credit risk funds primarily invest in corporate bonds and securities with lower credit ratings (BBB and below). These funds offer higher returns, typically around 10%-12% over the past decade; but they come with significant risk.
Key Risks: These funds are exposed to both credit risk (the risk of default) and interest rate risk. If the companies in which the funds are invested face financial difficulties, the value of the bonds can drop significantly, leading to capital losses.
Conclusion
Debt instruments in India are not without risk, and while many of them are considered safer than equity investments, they still carry risks that can affect returns. As explained in the PlanB Risk Ranking, investors need to assess their risk appetite carefully before choosing debt instruments. Understanding the risks involved such as interest rate risk, liquidity risk, and credit risk is essential for making smart investment decisions.
By considering your risk tolerance and investment horizon, you can select the right combination of debt instruments to build a balanced portfolio that aligns with your financial goals.
Frequently Asked Questions (FAQ)
1. What are the safest debt instruments in India?
Government Savings Bonds, Fixed Deposits, and Public Provident Funds (PPF) are among the safest debt instruments in India, offering low risk and steady returns.
2. Can debt instruments provide higher returns than fixed deposits?
Yes, instruments like corporate bonds, debt mutual funds, and tax-free bonds can offer higher returns than fixed deposits, but they also come with increased risk.
3. What risks should I be aware of in debt investing?
The main risks in debt investing include interest rate risk, credit risk, and liquidity risk. It’s important to understand how these risks can affect the returns of each instrument.
4. How do corporate bonds compare to government bonds in terms of risk?
Corporate bonds, even those with high ratings like AAA, carry more credit risk than government bonds. They offer higher returns to compensate for this additional risk.
5. Is investing in credit risk funds a good idea?
Credit risk funds can offer higher returns, but they carry significant risk. These funds are suited for investors with a higher risk tolerance and a longer investment horizon.
