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Why bond schemes are not for you
Our new lazy portfolio has become simpler. With even more intense research, we have arrived at the conclusion that our lazy portfolio for 2011 would consist of only a few equity schemes and bank fixed deposits for the fixed-income part and not bond funds. There were several reasons for eliminating bonds from our portfolio. The most important point is that the main aim of the lazy portfolio is steady returns—we are not aiming to maximise our returns in all market conditions. The advantages of bond funds are well-touted—lower risk and steady income, in addition to liquidity of investments. During an economic slowdown, bond funds tend to perform better than other investments. According to mutual fund houses, bond funds are considered better than FDs because bond funds provide the best opportunity to gain from interest rate movements. However, before you decide to jump in, it is worth asking: How do these merits of bond funds and their performance stack up against FDs? Bond funds are volatile and have not earned higher returns than bank FDs—except in 2004 and 2009 (see Moneylife, 2 June 2011).
Even adjusted for the tax breaks, bond funds don’t deliver a significantly higher return. This means that there is no need to pull out money from FDs and put it into a bond fund. But the bigger issue is that the principal in an FD is risk-free and return is non-volatile. The return from a bond fund can go down from 7% to 5%, if the bond fund manager does not time an interest-rate cycle properly. Even the best of bond managers have their ups and downs. An FD with major scheduled banks is completely safe, zero-risk and liquid.