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Gold & Debt: How to Allocate and How Much to Allocate?

by Tavaga Invest
Portfolio Diversification with Gold ETF and Fixed Income

By: Tavaga Research

Portfolio Diversification

Diversification of your portfolio simply means not placing all of your eggs in one basket. If your basket falls, all of your eggs will be crushed. Investors use diversification to spread the risk of their portfolio over several asset classes so that if any of them perform poorly, the other assets can compensate. This reduces the chance of loss while not affecting overall returns. Diversification’s purpose is to minimize risk and acquire the greatest potential return for your risk profile, not to enhance or decrease returns.

All Eggs in One Basket

In terms of distinct needs, all of the asset types must be divided. 

  • Stocks, for example, are used to build wealth through high-risk, high-return investments; 
  • Bonds/Debt instruments are used to earn a defined/fixed return with minimal risk; 
  • Gold ETFs are used to protect you against inflation;
  • Money market instruments are intended to meet urgent liquidity demands but may still provide a poor return on investment.

Gold ETFs and its role in your Portfolio

The ETF monitors the broad underlying index, such as the Nifty 50 and NASDAQ, or CPSE, and shares the diversified risk of index. ETFs are traded on stock exchanges and can be purchased/sold during stock market hours.

A Gold ETF is an exchange-traded fund (ETF) that tracks the domestic physical gold price. They are gold-based passive investment products that are based on gold prices and invest in gold bullion.

You’re buying gold in an electronic form when you buy gold ETFs. Gold ETFs may be bought and sold in the same manner that stocks can. 

Gold ETFs provide the following benefits:

Diversification Benefit- ETFs that invest in gold are a fantastic method to diversify your portfolio. In the face of volatile market conditions, a diversified portfolio can help you earn greater returns while lowering your risks. If the correlation is negative, the benefit of diversification is greater.

We take returns from Kotak Gold ETF and Nifty 50 for the period from January 2017 to February 2022. In the table below, it can be observed that even though the market was volatile, Gold ETF provided a stable return netting off the effect of volatility and thus providing the benefit of diversification. The correlation between these two came to -0.11. 

Tax Benefit- Long-term capital gains tax applies to gold ETFs that have been held for more than 3 years with indexation benefits. Gold ETFs, on the other hand, are exempt Wealth Tax and Securities Transaction Tax.

Inflation Hedge and Currency Hedge- Since gold may be used to hedge against currency fluctuations and inflation, it is seen as a secure investment. 

Gold ETF: SIP VS LUMPSUM

Through both SIP and lump-sum payments, investors may benefit from potential wealth creation through mutual funds. The frequency of investment is the key difference between SIP and lump sum investing.

SIPs are a way to invest in an ETF regularly, such as daily, weekly, monthly, quarterly, or half-yearly. Lump-sum investments, on the other hand, are a substantial investment made once in a specified plan. In addition, the minimum investment varies. SIPs can be started with as little as Rs.500 each month, while lump-sum investments typically require a minimum of Rs. 1,000.

SIPs may be a better investment choice for you if you have a little but consistent amount of money available for investing or you lack the skills, resources, or technology to take advantage of the market. Lump-sum investments may be more advantageous for individuals with a large investment amount high-risk tolerance, skills, resources, and time to monitor the markets closely.

Benefits of SIP

  • Close monitoring of the market can be avoided– Investors need to know when they are joining the market since lump-sum investments are a large commitment. When you invest in a lump sum during a market bottom, you get the best results. SIPs, on the other hand, allow you to invest at different phases of the business cycle. When compared to lump-sum investments, investors do not need to monitor changes in the market as actively.
  • Low initial investment- With as little as Rs. 500 each month, you may start investing in SIPs. Minimum investment of at least Rs. 1000 is required for a Lump-sum investment, while a bottom limit of Rs. 5,000 is required by most mutual funds in India.
  • The benefit of Averaged Costs- The cost per unit is averaged out across the full investment horizon since SIP leads to mutual fund purchases over distinct market cyclesMore units are purchased at a market low, compensating for purchases made during a market high. This might help you weather market fluctuations and maintain a stable pricing structure. Units may be sold when the market is performing well.
  • The benefit of Compounding- SIP investments earn interest, which is re-invested in the plan. The compounding effect helps in earning higher returns in this case.
  • Develops habit of saving and financial discipline- SIPs might help you develop a habit of saving regularly. You can set up an automated investing instruction with your bank at a frequency of your choice.

Risks in a Lump sum investment

Identifying a market bottom and putting a lump sum amount in a Gold ETF at that proper moment can yield substantial returns for investors who can understand market cycles. This is due to the basic investment philosophy of purchasing low and selling high. 

But Alas! Hardly anyone can do that. Catching the bottom and top, can only happen in dreams, may be once due to luck but not more than that, especially with big amounts involved.

An ill-timed investment, on the other hand, might result in losses and a loss of confidence. This is because if an investor’s lump sum is losing money, he or she may be hesitant to invest again. Lump-sum investments might be beneficial to experienced investors with extensive market expertise.

Debt and its role in your portfolio

Fixed income refers to financial securities that pay investors a fixed rate of interest or coupons until the maturity date. At maturity, investors get repaid the principle amount they invested. Government and corporate bonds are the most common fixed-income products. Fixed-income security payments are known in advance, unlike stocks, which may give no cash flows to investors, or variable-income securities, which may vary payments based on some underlying measure, such as short-term interest rates.

Fixed Cash-flow- So long as the issuer is solvent, bonds have more clear and predictable revenue sources in the form of coupons. While the yield on fixed-rate bonds fluctuates with the price, the coupons rarely vary.

Preservation of Capital- If the value of stocks falls significantly, a portfolio that primarily consists of equities might lose a significant amount of money. This is a particularly severe position for investors approaching retirement, and it highlights another crucial function of fixed income: capital preservation.

Goal Based Investing- Goals and time to achieve them are subjective and vary with individuals. More than 2 years ago, the debt market was not developed to provide bonds that could match with the maturity of your goals. Today, investors have the opportunity to invest in bonds that match the maturity of their goals. These instruments are known as Target Maturity bonds or target maturity funds.

A Target Maturity bond is also known as a “Defined-Maturity bond have maturities ranging from 1 to 10 years and provides investors the flexibility to buy bonds that meets their investment horizon. Now, an investor does not have to buy a fixed maturity bond like saying a 5-year bond when his investment horizon is only for 3 years and becomes exposed to the price risk. 

Portfolio Allocation

Allocation of asset classes in your portfolio should not only depend on the diversification benefit but also take into consideration your risk tolerance, goals, etc. According to the thumb rule, a young investor with sufficient wealth and no liabilities can take on more risk and therefore should allocate more to equity and less to gold and fixed income. However, as one gets closer to achieving goals, capital preservation is important and not outperforming the index or trying to generate a high return.  

On the other hand, an investor who is limited by short term goals or prefers to stay conservative with investments, should focus more on preserving the capital (from the beginning) and therefore may choose target maturity funds and Gold ETFs for the portfolio. 

Keeping investing simple is a very underrated subject in today’s age where there are numerous resources available to save and invest in. Team Tavaga genuinely believes that attractive and eye-catching products and schemes always come with unnecessary risk and must be only considered after consulting a SEBI RIA. Achieving goals and enjoying life are the two main objectives. If simple investment products can take care of these objectives, one has to ponder as to whether is it really worth taking the risk by buying unregulated or high-risk instruments.

A generous request to always consult a SEBI Registered Investment Advisor (SEBI RIA) and know every instrument in detail before investing your hard-earned money into it. The current SEBI RIA regulations are such that it has become almost impossible for an advisor to indulge in any activity that would be termed as mis-selling.

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