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Should you switch to fixed income now, like fixed deposits and debt funds?

You may think that you are preserving capital when you shift out of equity uncertainty today and shift back into the market when things are less chaotic and perhaps the uptrend has started again. This is a very difficult strategy to implement.

Getting out of equity and into fixed-income assets now might seem tempting given the volatility in equity prices, but it may prevent you from achieving your equity-linked financial objective. 

Usually, the amount invested in equity is meant for long term goals with the assumption of earning inflation plus returns. On the other hand, investments in fixed income happen with a view to either keep capital safe or earn a regular income. 

Even then you may think that you are preserving capital when you shift out of equity uncertainty today and shift back into the market when things are less chaotic and perhaps the uptrend has started again. This is a very difficult strategy to implement given that the change in trend can only be seen clearly in hindsight, and never before it actually happens. 

What you lose if you switch?

Let’s try to illustrate why switching to fixed income may cost you more, rather than help you preserve. On the 23rd of March, the Nifty 50 fell slightly more than 1100 points or 13% at the close of trade. This is a scary single-day fall on the back of the index falling 22% already since the start of the month. It’s also enough to convince one to leave equity assets and move to safe haven deposits or liquid funds. 

By switching out of equity now, you will do two things, make your unrealised losses permanent and secondly, you will preserve only the left-over capital. 

Had you done that on the next day itself, redeemed or switched your equity investments including systematic investment plans (SIPs) to fixed income funds then you would have missed the roughly 11% rally that followed in the next two days. The 11% you would let go of is more than what you would have been able to recover in a year by switching to fixed income funds or by switching to fixed deposits. Although the example above is taking into account what has happened in a matter of days, we must look at equities only as a long-term wealth creator. 

By switching out of equity now, you will do two things, make your unrealised losses permanent and secondly, you will preserve only the left-over capital. 

While there could be a further fall in equity value from here, historical experience in the market shows us that over a period of time stock prices begin to recover and track their fundamental value based on earnings growth. 

Think of your equity exposure as essential for your financial goal which is 7-10 years away. By switching to fixed income, you will not be able to make the kind of growth you need to achieve this equity-linked long term financial goal. 

There are costs involved

Every time you switch in and out of funds there are costs involved. Your equity fund may have an exit load for redeeming before completing a year of investment. Secondly, you will have to pay capital gains tax (if any) on exit from equity and when you invest in fixed income your tax liability changes. Depending on the product you may end up paying a higher tax in fixed income, thus, further derailing the course to achieving your long-term financial goal. 

If you have pencilled in inflation plus returns from equity assets to achieve your long-term financial goals, then you must remain in equity assets now, despite the sharp correction. You must also continue regular investments in equity for the months forward as that will help in taking advantage of lower prices for above-average gains. 

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