Indian investors are increasingly interested in equities, but speculative derivatives trading is a concern. Balanced portfolios and informed decisions are crucial, opines Dr Dhiraj, exclusively in Different Truths.
In the last few years, while the growing interest in equity markets among Indian retail investors is encouraging, there is a concerning trend of marketers and brokers aggressively promoting speculation in derivatives, such as forwards and options. As of 2024, retail participation in equity and derivatives markets reached a record high, with over 10 crore Demat Accounts registered, marking a significant rise from the pre-pandemic level of around 4 crore accounts (National Stock Exchange of India, 2024). Retail investors contributed nearly 50% of trading volumes in equity derivatives, with the National Stock Exchange recording monthly derivatives trading turnover exceeding ₹200 lakh crore (Trading Economics, 2024). This surge is driven by the promotion of derivatives as tools for quick wealth generation, often overshadowing their inherent complexity and risk, with studies indicating that over 90% of retail investors in derivatives incur losses. The Securities and Exchange Board of India (SEBI) has raised concerns over these trends, citing the misuse of leverage and inadequate risk disclosures. To address these issues, SEBI introduced stricter margin requirements and educational programs for investors. However, the aggressive marketing by brokers, emphasising high returns, continues to attract first-time investors, increasing their exposure to market volatility. This trend underscores the need for enhanced financial literacy to ensure informed participation in derivatives markets.
Investing is an essential part of financial planning. It is the vehicle that helps individuals achieve their long-term financial goals, build wealth, and secure their future. However, one of the most critical decisions any investor must make is selecting the right investment strategy that aligns with their financial objectives and risk tolerance. In India, retail investors have traditionally displayed a preference for fixed-income instruments, such as bank deposits, Public Provident Fund (PPF), and post office schemes, often prioritizing safety and stability over growth potential. While this approach has its merits, particularly for risk-averse investors, there has been a notable shift in recent years. The younger generation, equipped with easy access to information and trading platforms, is increasingly attracted to equity investments.
While the growing interest in equity markets is encouraging, it raises an important question: how can Indian retail investors balance their portfolio to optimize wealth creation while managing risk effectively? The key lies in adopting a balanced approach that includes both fixed-income investments and equities, ensuring the right Asset Allocation based on individual financial goals and risk profile. This article explores the importance of maintaining this balance, the risks of extreme investment strategies, and the ways to create a well-rounded portfolio.
Traditional Indian Investment Options
India has long been a nation where a conservative approach to savings and investments has been deeply ingrained in the culture. The primary reasons for this are historical and psychological. For many years, Indian investors had limited access to diverse financial products, and the risk-averse mind-set was reinforced by the experiences of economic instability, inflation, and currency fluctuations. Fixed-income instruments such as bank deposits, PPF, and post office schemes offered security, steady returns, and the assurance of government backing, making them the go-to options for most households.
For the typical middle-class Indian family, it is not uncommon to find a collection of fixed-income investment documents—be it bank deposit certificates or PPF account passbooks—carefully preserved as part of their financial legacy. These instruments have, over generations, come to represent a safe haven for savings. The mind-set is simple: keep the principal safe and earn predictable returns, no matter how small, rather than take on the risks associated with equities or other more volatile asset classes.
While this approach worked well in a relatively low-interest-rate environment, it has, in recent years, proven less effective in achieving significant wealth accumulation, especially in an era where inflation erodes the purchasing power of money over time. As a result, a paradigm shift has been occurring in the Indian investment landscape.
Shift Toward Equities and the Risks Involved
In the last decade, the rise of digital platforms, online trading, and a wealth of financial information available at our fingertips has revolutionised the way Indians approach investing. The younger generation, especially millennials and Gen Z, are embracing the stock market more than ever before, drawn by the potential for high returns that equities can offer. Equity mutual funds, in particular, have gained significant popularity, with investors pouring money into these funds to tap into the growth of businesses and the broader economy.
As stated earlier in the introductory paragraph of this article, while the enthusiasm for equities is a positive development, it has also led to a dangerous trend. Many young investors, excited by the success stories of those who have made fortunes in the stock market, are allocating their entire portfolios to equity investments. The allure of potentially higher returns is hard to resist, but this approach comes with considerable risks. The stock market, though lucrative in the long run, is also highly volatile in the short term. As we have seen in the recent market decline in the last few months, stock prices can fluctuate dramatically, causing significant losses.
Lessons from Market Volatility
Indian stock markets exhibited notable volatility influenced by global and domestic factors in the last few months. This has served as a stark reminder of the risks associated with an overly aggressive investment strategy. The sudden decline caused panic among many retail investors who had put all their money in equities, and many rushed to exit their positions at a loss, driven by fear and uncertainty. While the market has shown signs of stabilization, this event underscores the importance of diversification and the need for a well-thought-out asset allocation strategy.
This is where the concept of Asset Allocation becomes crucial. Asset allocation involves dividing one’s investments across different asset classes—equities, fixed-income, real estate, and commodities—based on individual risk tolerance, time horizon, and financial goals. The objective is to optimize returns while mitigating risk by ensuring that the portfolio is not overly reliant on any one asset class, particularly equities, which can be volatile in the short term.
Strategies for Wealth Creation – Diversification and Balanced Asset Allocation
A balanced investment approach typically includes a mix of equities and fixed-income assets, allowing investors to enjoy the best of both worlds. Equities, particularly through equity mutual funds, provide higher potential returns but come with higher risk and volatility. On the other hand, fixed-income investments offer stability, regular income, and lower risk, making them ideal for preserving capital and providing a cushion during market downturns.
The concept of diversification is central to any well-structured investment strategy. By spreading investments across different asset classes, investors can reduce the overall risk of their portfolio. For example, when equity markets are performing well, the fixed-income portion of the portfolio may underperform, but it will serve to stabilize returns and protect capital. Conversely, when the equity market experiences a downturn, the fixed-income component can help cushion the blow, ensuring that the investor’s overall portfolio remains resilient.
This balanced approach ensures that investors are not overly exposed to the risks of one asset class, such as equities, while also taking advantage of the growth potential that equities offer. Regular rebalancing, which involves adjusting the portfolio to maintain the desired allocation, is key to maintaining this balance over time.
Role of Fixed-Income Instruments
While equities are essential for long-term wealth creation, the role of fixed-income investments cannot be overstated. Fixed-income instruments such as bonds, fixed deposits, and government-backed schemes like PPF and Sukanya Samriddhi Yojana (SSY) etc. provide a reliable income stream and offer safety during market turbulence. For conservative investors, these instruments form the backbone of their investment portfolio, providing the stability and peace of mind that comes with predictable returns.
Even for aggressive investors who are more inclined to take on risk, fixed-income assets play a vital role. They serve as a buffer against market volatility, helping to maintain a steady level of income during periods of market downturns. Studies have shown that portfolios with a mix of both equities and fixed income tend to perform better over the long term compared to portfolios heavily concentrated in equities.
Hybrid mutual funds, which combine both equity and debt, are an excellent option for investors looking for an automatic balance between risk and return. These funds offer the advantage of diversification and professional management, ensuring that the portfolio remains balanced and aligned with the investor’s risk profile. Let us discuss some of the prominent Indian government fixed-income securities for retail investors in the following section.
Major Indian Government Fixed Income Instruments for Retail Investors
India offers a variety of government-backed fixed-income securities for retail investors who are looking for safe and stable investment options. These securities are backed by the government, making them relatively low-risk compared to other investment avenues. For retail investors, these fixed-income options are particularly attractive due to their safety, tax benefits, and predictable returns. In this article, we will discuss some of the major government-backed fixed-income securities available to retail investors in India.
1. Government bonds: Government bonds are debt securities issued by the central or state government, considered one of the safest investment options due to being backed by the full faith and credit of the government. Indian government bonds come in various maturities, including short-term, medium-term, and long-term bonds, catering to different investment horizons. These bonds offer a fixed coupon rate, meaning investors receive a predetermined interest at regular intervals, typically every six months or annually. The returns are generally lower than riskier investments, but their safety and reliability make them appealing to conservative investors. These bonds can be traded in the secondary market, although liquidity depends on the bond’s maturity and market conditions. Examples include Government of India Savings Bond and State Development Loans (SDL).
2. Public Provident Fund (PPF): Public Provident Fund (PPF) is another popular long-term savings and investment scheme in India. Despite its long lock-in period of 15 years, PPF offers tax-free returns, a government-backed guarantee, and tax deductions under Section 80C of the Income Tax Act. These features make it an excellent choice for long-term investors seeking to secure their fixed-income portion. PPF accounts can be opened in banks or post offices with a minimum annual investment of ₹500 and a maximum limit of ₹1.5 lakh. The interest rate, set quarterly by the government, is typically higher than fixed deposits, and the returns, including the maturity amount, are tax-free. While PPF has a 15-year lock-in, partial withdrawals are allowed after six years, and loans can be taken from the third year onward.
3. Sovereign Gold Bonds (SGBs): Sovereign Gold Bonds (SGBs) are government securities issued by the Reserve Bank of India on behalf of the Government of India, providing an alternative way to invest in gold without the need to buy it physically. Each bond is denominated in grams of gold, and the interest rate is fixed at 2.5% per annum, paid every six months. The bonds have a tenure of eight years, with an option to exit after the fifth year. The price of the bonds is linked to the market price of gold. While the interest earned on SGBs is taxable, capital gains on maturity are tax-free, provided the bonds are held until maturity. SGBs can be traded on the secondary market after the fifth year, offering liquidity, though they carry the same risk as gold price fluctuations.
4. National Savings Certificates (NSCs): National Savings Certificates (NSCs) are a popular fixed-income option issued by India Post, providing a safe investment avenue for conservative investors. Available in denominations ranging from ₹100 to ₹10,000, NSCs have a five-year lock-in period, and interest is paid at maturity. The interest rate is fixed and revised quarterly by the government, typically offering a rate higher than fixed deposits. NSCs are eligible for tax deductions under Section 80C, but the interest earned is taxable. While withdrawals are not allowed before the five-year lock-in, they can be transferred to others or used as collateral for loans.
5. Senior Citizens Savings Scheme (SCSS): Senior Citizens Savings Scheme (SCSS) is designed for Indian citizens aged 60 and above, offering a steady income option for senior citizens. The scheme requires a minimum investment of ₹1,000, with a maximum limit of ₹15 lakh in a single account. The interest rate is around 8% per annum, payable quarterly, and the scheme has a tenure of five years, extendable by an additional three years. Although the interest earned is taxable, investors can claim deductions under Section 80C for the principal investment. Premature withdrawals are allowed but with a penalty. SCSS is considered a low-risk investment option due to its government backing.
6. Post Office Monthly Income Scheme (POMIS): The Post Office Monthly Income Scheme (POMIS) provides fixed-income investors with regular monthly income, making it an attractive option for those seeking a steady cash flow. The investment tenure is five years, with a minimum investment of ₹1,500 and a maximum of ₹4.5 lakh in a single account, or ₹9 lakh in a joint account. The interest rate ranges from 7% to 7.5% per annum, paid monthly, and the interest earned is taxable. While there are no tax benefits under Section 80C, POMIS accounts can be transferred to other post offices, and partial withdrawals are allowed with penalties.
7. Tax-Free Bonds: Tax-Free Bonds are long-term debt instruments issued by public sector companies and government-backed entities, with the key feature being the tax-free nature of the interest earned. Although the interest rate on tax-free bonds is generally lower than other fixed-income options, their appeal lies in the fact that the interest is exempt from income tax, making them especially attractive for investors in higher tax brackets. These bonds typically have a tenure of 10 to 20 years, with a minimum investment amount of ₹10,000. While the bonds are long-term, they can be traded on the secondary market, providing liquidity, though the secondary market can be less liquid compared to other instruments.
8. Sukanya Samriddhi Yojana (SSY): Sukanya Samriddhi Yojana (SSY) is a government-backed savings scheme introduced in 2015 under the ‘Beti Bachao Beti Padhao’ initiative, aimed at promoting the welfare of the girl child by encouraging parents to save for their daughters’ future education and marriage. It allows parents or guardians to open an account in the name of a girl child under the age of 10, with a maximum of two accounts per parent (or more in the case of twins). The scheme requires a minimum annual deposit of ₹250, with a maximum limit of ₹1.5 lakh per year. The interest rate, typically ranging from 7.6% to 8% per annum, is revised quarterly and is compounded annually. The contributions to the SSY account are eligible for tax deductions under Section 80C, and both the interest earned and the maturity amount are tax-free, making it a highly attractive investment option. The account has a lock-in period of 21 years, and contributions are allowed for up to 14 years. The account matures when the girl turns 21 or upon marriage at 18, whichever comes first, and at this time, the total balance, including interest, can be withdrawn. Partial withdrawals are allowed for higher education or marriage after the girl reaches 18, up to 50% of the balance at the end of the previous financial year. The Sukanya Samriddhi Yojana offers a disciplined savings method that helps ensure financial security for a girl child, providing both tax advantages and long-term financial growth.
In summary, Indian retail investors have a variety of government-backed fixed-income securities to choose from, each offering its own set of benefits and features. The best investment option for an individual depends on factors such as their investment horizon, risk tolerance, and financial goals. Government securities like PPF, NSC, and SCSS are ideal for conservative investors seeking safety and stability, while options like SGBs and tax-free bonds may appeal to those looking for tax advantages or exposure to specific sectors like gold. By diversifying their investments across a range of these government-backed securities, retail investors can build a well-rounded, low-risk portfolio that offers stability, safety, and predictable returns.
The Sweet Spot Between Risk and Return – Finding the Right Balance
So, what is the ideal balance between equity and fixed income in a retail investor’s portfolio? The answer depends on individual factors such as age, financial goals, risk tolerance, and investment horizon. Younger investors with a long-term horizon and higher risk tolerance may choose to allocate a larger portion of their portfolio to equities, while older investors or those with lower risk tolerance may lean more heavily towards fixed-income instruments.
A commonly recommended rule of thumb is the ‘100 minus Age’ rule, which suggests that an investor should allocate 100 minus their age to equities and the remaining portion to fixed-income investments. For example, a 30-year-old might allocate 70% of their portfolio to equities and 30% to fixed income, while a 50-year-old may consider a 50-50 split. However, this is just a guideline, and the exact allocation should be tailored to the individual’s specific needs and preferences.
The key takeaway is that a well-balanced portfolio is not about favoring one asset class over another but about finding the right mix that aligns with one’s goals and risk profile. By adopting a diversified approach and periodically rebalancing the portfolio, investors can mitigate risks, maximize returns, and build wealth steadily over time.
Conclusion
In conclusion, the Indian retail investor’s journey toward wealth creation requires a balanced and disciplined approach to investing. While the growing interest in equities is a positive development, it is crucial to remember the importance of diversification and asset allocation in managing risk. A portfolio that combines both equity and fixed-income investments can provide the best of both worlds: the growth potential of equities and the stability of fixed income.
By maintaining a balance between these two asset classes and regularly rebalancing the portfolio, investors can navigate market cycles with confidence and create lasting wealth. It’s not about avoiding fixed-income investments or chasing the highest returns in the equity markets; it’s about finding that sweet spot where both asset classes work together to build a solid foundation for long-term financial success. As Indian investors embrace a more dynamic investment approach, it is essential to remain disciplined and avoid the temptation of extreme strategies. A balanced portfolio that includes both equities and fixed-income investments, along with regular monitoring and rebalancing, is the cornerstone of sustainable wealth creation.
References and Bibliography
Ministry of Finance, Government of India. (2024). Public Provident Fund (PPF) and Sukanya Samriddhi Yojana (SSY): Policies and updates. Retrieved from https://finmin.gov.in.
National Stock Exchange of India. (2024). Market performance and participation data. Retrieved from https://www.nseindia.com
Reserve Bank of India. (2023). Sovereign Gold Bonds: Investment guidelines and tax benefits. RBI Bulletin, 12(7), 34–42.
Securities and Exchange Board of India. (2023). Investment strategies and risk management: Guidelines for retail investors. Retrieved from https://www.sebi.gov.in.
Trading Economics. (2024). BSE Sensex and derivatives trading statistics. Retrieved from https://www.tradingeconomics.com
Picture design by Anumita Roy
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