Should you realign your fixed income portfolio now?

While budget increased dividend distribution tax on debt investment and announced measures for fiscal control, RBI followed it with reducing interest rates. Both these decisions impact short and long term investment of your debt exposure. Since we are very close to end of financial year, it will be a good time to restructure our investments before the budget provisions becomes applicable

Let’s analyze what how debt investments will be impacted and what measures you can take:

1. Short Debt mutual Funds- In budget 2013 the Dividend Distribution Tax paid by companies is increased from 12.5% to 25%. This may not matter in equities but short term debt mutual funds will become unattractive. Ultra short term funds, short term debt funds, FMPs, MIPs and even long term debt funds will have higher taxability in case of dividend payout. Individuals, especially retirees, who made their strategies of earning regular income through dividend received from debt mutual funds will feel the impact. Even strategies of Systematic Transfer Plans such as from ultra short term funds to equities when daily or weekly dividends are opted will be ineffective. The benefit of investing in debt mutual funds will clearly shift more towards growth option where the taxability is lower in case of a year or more horizon. For short term investments i.e. less than a year, the dividend option will not find favor with investors in 10% or 20% tax slab and growth option is equivalent to investing in traditional products like bank FDs. But for individuals in highest tax slab, the gap may have been reduced, but the benefit of lower tax will still be there. The biggest setback is for retirees who would have planned their regular income need through dividend option. Systematic Withdrawal Plan will be much more effective strategy for such investors. Thus all short term debt investments with dividend option or any other such strategy will have to be reviewed and realigned after analyzing the need and options available.

Check out the performance of Short term funds and Long term funds

2. Long Term Debt Mutual Funds- Long term debt funds such as income and gilt funds generate returns when interest rates decline. Gilt funds entire exposure is in government securities and so they are the preferred avenue in such scenario. But considering the high government borrowing next financial year which may reach to an oversupply situation and RBI signaling a tough stance forward, the returns from gilt funds may be restricted. Income funds which invest in corporate bonds along with G-Sec Exposure will be poised good to take the benefit of this opportunity. With a horizon of 2-3 year they can be a viable investment option. The other category which may find favor with investors is flexi debt or dynamic bond funds which are keeping average maturities of securities at 2-3 years and can align it with change in situation.

2. Small savings Schemes- The interest rates for next financial year will be declared on 1st April 2013. With RBI reducing interest rates just a month before and earlier, it will be be seen what rates are offered. However, these funds are needed by the government for various long term projects and so the it is keen to increase the share of investors wallet in them. In line with other measures taken now and RBI stance on further rate cuts, the government will take effort to keep the interest rates so that investors interest in small savings schemes do not falls.

4. Fixed Deposits & FMPs- A 1-5 year fixed deposits is offering 8-9% return to investors today which will reduce in line with RBI reducing interest rates in future. FMPs offer higher returns due to indexation benefit and capital gains taxation. The yields from this instrument will also go down if the rates fall further. With current yields & rates both these instruments are a good bet for 1-2 year investment for different category of investors.

The budget and RBI monetary policy has come within a span of one month and both have put an onus on investors to review their investments. A financial year end is a good time to review your investments and take measures to reduce the impact on your earnings next year.