Is your investment portfolio leaking? Fix these 5 money gaps in it

Few investors run a tax-optimised portfolio, which is often full of tax-inefficient investments such as FDs & bonds. Amid low interest rates, this is a double whammy. A 3-year bank FD yielding 5.4% actually yields post-tax returns of 3.78% in the 30% tax bracket. If adjusted for inflation, the real return is negative. Instead, consider tax-efficient alternatives like debt funds.

Apart from this, investors leak taxes by not taking advantage of certain tax provisions available under law. Couples can minimise overall tax liability by dividing investments between husband and wife. Harvesting tax losses is another provision available at your disposal. LTCG can be set off against both long-term and short-term capital losses. But STCG can be set off only against short-term capital losses. The best part- gains in equities can be set off against losses in debt, gold or property.

Trying to time the markets— stopping and restarting investments— can take a chunk out of your portfolio. Investors who sell at fresh market peaks expecting a correction often rue their decision as markets keep scaling newer heights. Unless you need the money, it is best to stay invested in the market to capture the upside. However, also weed out chronic underperformers from your portfolio timely. Keep reassessing fund performance every 2-3 years. You may pay a huge opportunity cost if you remain invested in sub-standard investments and laggards.

Your profits could also leak if you keep investing in dividend plans (now known as Income Distribution cum Capital Withdrawal plans) of mutual funds. When you opt for these, you are withdrawing from your fund instead of infusing. It is better to invest in the growth option and withdraw as per your needs.

Risk profiles of investments change with time. Mutual funds change mandates and cross over to another category not aligned with the original risk profile. Such changes may not suit all. In debt funds, it is particularly important to watch out for any deterioration in the liquidity or credit profile. For instance, some funds belonging to perceived safer fund categories like low or short duration may carry exposure to lower credit quality bonds. Investors can now rely on the new riskometer to track such changes. It assesses debt MFs on credit risk, interest rate risk & liquidity risk. The riskometer is updated monthly and will immediately flag if any indicator deteriorates materially.

Most bad investments stem from a narrow understanding of own risk tolerance. Further, you must revisit your risk profile occasionally to reflect life-altering circumstances, such as birth of a child, a large inheritance or sudden illness of a loved one.

At any point of time, your portfolio must have enough liquidity— assets must be readily convertible into cash without having to sell at a discount. The pandemic has highlighted the importance of having enough liquidity at all times. Large sums tied up in traditional plans or real estate will not come to your aid at such critical junctures. Investments such as PPF and EPF offer liquidity only when certain criteria are fulfilled. Investments in tax-saving equity funds and Ulips are subject to a lock-in of 3 and 5 years, respectively.

Keep your exposure to illiquid investments in check and review your liquidity position regularly. The liquidity should not be confined only to the emergency corpus. A considerable portion of your regular portfolio should also be fairly liquid. Shares, bonds, equity and bond funds are all liquid in nature and proceeds get credited within 2-4 business days. At the same time, don't go all out on liquidity. Keeping large sums in savings accounts, FDs and even liquid funds will not fetch your portfolio returns.

You must match your liquidity needs with appropriate investments. When investing for regular income, the frequency of interest payout must match your cash flow requirements. For example, if saving for your daughter’s education, don’t invest only in Sukanya Samriddhi Yojana. The account allows only partial withdrawal of up to 50% of the account balance after the girl turns 18. The balance can be withdrawn only when the account matures in 21 years.

Traditional insurance plans, for example, come at steep costs that eat a chunk of the premium initially. Costs can be as high as 70-90% of the first year premium and eat up to 15-20% every renewal. Additionally, such plans come with heavy surrender penalties, making early exits very costly. Comparatively, Ulips have much lower embedded costs.

Actively managed mutual funds have been panned for underperforming the index even as they charge a tidy expense ratio for beating it. Passive investing is finding favour partly due to lower costs. Several index funds and ETFs have been launched. ETFs now charge as low as 0.05%, lower than what even the average index fund charges but also attract brokerage costs, besides taxes and depository charges. Further, trading volumes of most ETFs are very poor. This lack of liquidity often creates wide divergences between the fund NAV and the price at which it can be bought or sold. What you save in expense ratio is more than nullified by this impact cost. Comparatively, index funds do not face such issues.