Remember the first time you tried to swim? You probably swung your arms and legs in every direction trying to stay afloat in the water. But when the coach came and corrected your mistakes, you started swimming better. It is always easy to perform a task in a better way once you know the mistakes that you’d naturally make. This way, you can avoid the mistakes altogether and concentrate on the task. Same is the case with investments such as debt instruments. In this article, let’s explore some of the common mistakes to avoid while investing in debt instruments.
1) Investing in low-quality bonds
Don’t invest in bonds that have a low credit quality. Each and every bond in the market is given a grade to indicate its credit quality. Independent rating services offer these ratings on bonds. Bonds with a rating of AAA (or Aaa) are investment grade bonds and are considered to be of the highest quality. In comparison, bonds with a rating of B or C are considered to be junk bonds. Such bonds offer a higher rate of interest in order to attract investors. Avoid bonds as a debt investment if you are interested in stable and consistent returns.
2) Ignoring inflation
Debt instruments like bonds offer stable returns and reduce volatility in your portfolio. However, in the long term, the returns may not be very high. This can be a big problem when inflation comes into the equation. For instance, imagine you buy a 15-year bond that offers 5% fixed coupon rate. Since the returns remain constant, your purchasing power may in fact come down over the years due to inflation. Keeping this in mind, it is a good idea to expand your horizon and incorporate investments that offer higher returns to your portfolio.
3) Investment-goal mismatch
Identify your investment goals and invest accordingly such as in short term debt instruments. It sounds simple but surprisingly, many investors make mistakes in this aspect. For example, the common goal of people nearing retirement is to earn a little income in addition to capital protection. Here, the priority is capital security. In this scenario, investing in emerging market debt or a junk bond may not be the right decision. Instead look for a bond (government bonds, for example) that offers low volatility and capital safety.
4) Selling bonds when interest rates rise
Bond prices have an inverse relationship with interest rates. That means, when interest rates rise up, bond prices go down and vice versa. As a result, the price of a bond can vary subject to the change in interest rates. Many fixed income investors tend to dispose their investments based on these fluctuations. However, this is not the right option. It is best to hold your securitised debt instruments until the maturity date. This is because of the simple fact that you could end up with a loss in case you sell your bond and the interest rates move in the opposite direction.
To sum up
Debt instruments are known to offer stable returns and safety of capital (not to forget peace of mind). However, it is important to avoid the above mistakes investing in debt so that you can achieve the best returns possible on your investments.
A number of investors have learnt that it is wise to invest steadily in the market. However, only a few of them track their investment performance on a regular basis. An appropriate review of your debt funds' performance can assure you stay aligned with your investment objectives. It is a good idea to comb out the funds that are not offering returns as good as their counterparts. However, a crucial point is that investors must provide sizeable amount of time to grow their debt instruments. In theory, a time frame a year and upwards must be given to a debt investment to obtain decent yields.
Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.