How do you divide a fixed-income portfolio into different categories?

New Delhi: Personal finance relies heavily on fixed-income instruments. It is critical to divide the fixed-income portfolio into different buckets with different use cases as part of the financial planning process.

• Emergency liquidity bucket (emergency fund bucket).
• Core fixed income bucket for goal planning, tax savings, improved tax efficiency, and overall portfolio stability (asset allocation).
• Satellite bucket - for tactical communications.

Setting up an emergency fund

This bucket is designed to handle a wide range of emergencies, from job loss to extended illness. We believe you should concentrate on two things when creating your emergency fund.

First, the money must be available quickly and not lose value over time due to inflation. The second part is critical because if you keep the funds in savings or fixed deposit accounts and no emergency occurs, you will need to replenish the emergency funds every few years. A better strategy would be to put up to three months' worth of emergency funds in a fixed deposit and the remainder in conservative hybrid funds with higher after-tax returns. This will benefit you as:

• In three years, conservative hybrid funds will become tax efficient.
• Net banking allows you to liquidate fixed deposits at any time.
• Select conservative hybrid funds with equity allocations of less than 15%.

Create a fixed-income basket

This basket, if properly constructed, can save a significant amount of tax, be aligned with various financial goals, and play an important role in asset allocation. Public Provident Fund (PPF), Employees Provident Fund (EPF), and Tier 1 of the National Pension Scheme are three instruments that are a no-brainer and should not be overlooked when planning your investments in this bucket (NPS).

PPF, EPF, and NPS all have EEE status, which means they receive a tax deduction at the time of investment, interest earned is tax-free, and maturity proceeds are also tax-free. Finally, Sukanya Samridhi Yojna, which also has EEE status, is an option if you have a daughter and want to increase your allocation in your core fixed income basket.

For the average retail investor, the above vehicle may be sufficient; however, for those with a larger investible surplus, additional fixed income allocation can be directed toward target maturity funds (mapped to financial goals), schemes following roll-down maturity, G-Sec ETFs, and open-ended funds with high portfolio quality (low credit risk) and low average maturity (low-interest rate risk).

Products such as RBI bonds, Pradhan Mantri Vaya Vandana Yojana, and the Post Office Senior Citizen Scheme are good investment options for senior citizens looking for consistent payouts.

• Life insurance companies' guaranteed return products should be avoided.
• Annuities should also be avoided because they are inefficient in terms of both taxation and return.
• We only refer to the fixed income portion of the allocation in NPS.

Working on a satellite bucket

A retail investor does not require this bucket. However, to take advantage of this bucket, you must be familiar with global and local macroeconomic scenarios. This bucket is only for investors with a sizable investible surplus and must be created under the supervision of a professional.

Satellite buckets are used to profit from changes in interest rates or to play the credit cycle. Wealthy people primarily use this bucket for tax-free bonds (to play the interest rate cycle), market-linked debentures (for short-term tax efficiency), and long-duration and credit risk funds. For example, if you believe that interest rates will fall, you should consider investing in medium to long-term bond funds, which will provide higher returns in this scenario.

• Lower-rated bonds issued by new-age platforms carry too much risk.
• Annuities should also be avoided because they are inefficient in terms of both taxation and return.