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debt and equity: Is it wise to create a zero-debt portfolio in today’s time?


Warren Buffett once said: “Market fluctuations are your friend, not your enemy.” However, the question is how you move the equity market‘s ebbs and flows in your favor. Should you go all in when it comes to equity or not? There is always a lot of debate on zero-debt portfolios and it often confuses new investors. To make it easier, ETMarkets spoke to Chirag Muni, Executive Director, Anand Rathi Wealth Ltd on this. Excerpts:

Let’s delve deeper into debt and equity first. Can you tell the readers the difference between debt and equity?
Chirag Muni: At the fundamental level, debt is nothing but you are giving a loan to someone and equity is nothing but you are participating in the growth of the company. From an investment perspective, in India, there are four broad asset classes. There is real estate, equity, gold and debt. So, real estate and equity become your growth asset classes and generally debt and gold would be your defensive asset classes.

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Equity helps you invest in the capital market via mutual funds, stocks, PMS, etc. On the flip side, debt is about investing in instruments like bonds, fixed deposits (FDs), and government securities, offering a different way to get into investing.

Debt and Equity have a low correlation and a combination of these two assets can help target a return around 12% based on your investment horizon. Equity mutual funds have delivered an average return of 14% over a longer tenure and Debt mutual funds have approximately delivered a 7% return.

Is it wise to create a zero-debt portfolio?
Chirag Muni: It is possible to create a zero-debt portfolio. Looking at the last 24-year perspective, if I am a one-year investor in Nifty (I invested in Nifty on 1st Jan 2000, sold it on 1st Jan 2001. Similarly, 2nd Jan and 2nd Jan). If you look on a rolling basis, the average one-year return is 15%, which is a very good return.

To understand this better we analysed the probability of Nifty 50 delivering returns in different tenures to understand over different periods how Nifty 50 performed. For an investment horizon greater than 5 years, there is an 86% probability of Nifty 50 delivering a return greater than 6% (plus inflation).

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Should Equity be perceived as risky?
Chirag Muni: If you look at the average 23-year return on Nifty is about 13.2%, which is the return. So, if you are a 23-year investor, 13.2. But to make that 13.2, you have to live through 23 years. And if I just break it up into 23 calendar years, there were only four instances where there were negative returns on a calendar year basis on Nifty. So, 2001 was a tech bust (-16.2%), and the financial crisis came in 2008 (-51%). In 2011, we saw about 25%. And then in 2015, we saw about negative 4%. So, the point I am trying to make is that 83% of the times in the last 23-24 years, Nifty has been positive on a calendar year basis. There have been only four instances where there is a negative return. So, it is perceived to be more riskier, but if you have time on your side, it is not as risky as you think.

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Generally, the Nifty or the market mirrors the nominal GDP returns. When I say nominal GDP is nothing but the real GDP plus your inflation. So, for the last 22 years, the average Nifty return has been 13.1, like I said, and the nominal GDP has been 12.3%. So, almost mirroring the nominal GDP.

Even if I break it up in 10-10-year brackets from 2001 to 2012 the nominal GDP was 13.6%, whereas Nifty delivered a 14.9% return. Similarly, 2012 to 2023 Nifty delivered 11.4 and the nominal GDP is 10.9. So, the point I am trying to drive is going forward as well, the way India is shaping right now if you look at any agency, all are expecting at least a 7% growth for the next few years on the real GDP and a 5-6% inflation is the norm in any case. So, 12-13% return expected from a longer-term basis like I said is a very high probability.

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Why is debt important when it comes to a portfolio?
Chirag Muni: As I said the long-term return has been 12-14% on the Nifty, but you have to live through those years to make your 12-13% return, and many times if you see large volatility, people tend to come out of equities and do not enjoy their return because on a 10-year basis there will always be two-three-year cycle which will disappoint you in Nifty. To give stability to your portfolio, debt may be required if you do not want to go through this volatility.

So, if you have 50-65% into equity and if let us say market drops also which I said that in the long-term it does not drop so much, but assuming even the market drops 30-40%, your 65% might come down but the rest of the debt portion will make up for it in a three, three-and-a-half, four-year scenario. So, in a four-year kind of scenario, your portfolio is actually capital protected because of the high interest rate because you are getting 7-8%. Debt instruments give you higher liquidity and are stable in comparison to equity. It balances out shortcomings of equity in the long run too.

When it comes to debt allocation, which is the best way to allocate debt in your portfolio if we are talking about, say in terms of duration (short term, medium term or long term)?
Chirag Muni: So, if your portfolio is for a short term, which is a very short term, which is three years, then of course you should have large proportions in debt. It could be 50-60-70% could be in debt and 30% in equity. But if you have a horizon of more than three years, I think you can probably reverse the trend of getting 60-70% into equity and 30% into debt. And if you have, of course, a five-year horizon, then I would say 80% equity and 20% debt because I said in a five-year scenario, there is an 86% chance you will make more than debt in any case. So, it will allow you to have 80% equity. I think this is the ideal mix that can give you a reasonable return.

Is there any case where an investor can skip having debt in their portfolio?
Chirag Muni: Absolutely. If you have a 6-year plus horizon, then there is a case to have 100% equity. If you are not worried about volatility and won’t touch that money. There is a high chance you will make more than debt. Of course, you can realign it based on what the valuations across market caps, etc, are, but staying in equity would be important from a 6- to 10-year perspective.

Watch: Is it possible to create zero debt portfolio?



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