Don't go overboard with tax-free bonds

Many a time we have seen people talking about losses in investing world and hence people seek to invest in low risk fixed income instruments such as the ongoing tax-free bonds. No doubt it is a good idea to invest in the ongoing long term tax free bond issues such as India Infrastructure Finance Company Ltd (IIFCL), given the lower risk of default and a possibility to earn capital gains over the next couple of years as the interest rates are expected to come down. But that does not mean one should bet his all monies on one such idea. It has been observed that investors redeem money from equities as they obtain the cost of buying shares with rising markets, which they subsequently invest in bonds.
 
Such a tendency can be counterproductive if it is contradicting the ideal asset allocation of an investor. Consider an example, if an individual aged 30, who plans to retire at the age of 60, is redeeming all his money from equity mutual funds and parking it in tax-free bonds. This is not a wise idea. It is better to stick to asset allocation and keep rebalancing it at regular interval, let’s say once in a year.
 
If you are young, and has some appetite for risk you should ideally have some exposure to equities. It is better to consider investing at least 50% of money in equities with the long-term view. An aggressive individual may have up to 75% of his money in equities, whereas a conservative investor may choose to keep his equity exposure to 10% of total portfolio value. Whatever be the case an allocation to equity is a must along with fixed income exposure.
 
An important point to note here is to understand that volatility in markets are but violent waves in a sea which rise and go, but eventually subside giving tranquility of mind. So, one should not be much affected by intermittent volatility in the equity markets. One should learn to live with it. Fixed income as an asset class can offer you predictable returns in short to medium term with a little volatility a! s compared to equity, but in the long term it can generate almost nil returns when adjusted to inflation.
 
Also fixed income investors should never forget the time-tested wisdom in the financial markets: it is difficult to predict interest rates in the long-term but it is easy to predict long-term expected returns from equities. If you are investing for the long-term, typically more than five years, do not go overboard on fixed income.

The author is the co-founder and director of creditvidya.com