What are Debt Funds?
Open-ended mutual fund schemes that predominantly invest in fixed-income debt se-curities are known as debt funds. The underlying assets comprises treasury bills, government bonds, certificate of deposits, debentures, corporate bonds and various other money-market instruments.
Debt funds are one of the safest investment instruments available to investors, who wish to earn optimal returns on their investment, without betting on risky avenues. Al-so, the returns are quite stable, as opposed to returns from equity funds which are highly volatile.
Benefits of Investing in Debt Mutual Funds
Fixed Returns
As debt funds primarily invest in securities that yield fixed-interest, returns from them are guaranteed. However, there is a minuscule possibility of a debt fund not perform-ing upto the mark, this happens when the invested securities have low credit rating, or the interest rate movement is negative.
High Liquidity
Overnight Funds or Liquid Funds are categorised under debt funds which have deliv-ered optimal returns in the short run over the years. These funds are highly liquid and are a perfect safe haven for idle money in hand. One can redeem the units as per his/her convenience.
Better Returns than Traditional Savings Methods
When compared to returns delivered by traditional savings methods such as Savings Accounts or Bank Fixed Deposits, debt funds have always fared well. While savings accounts have delivered around 4-5% annual returns over the years, liquid funds have delivered returns at the average rate of 7%. Also, instant redemption facility in case of liquid funds make them a better alternative to savings accounts.
Diversification
When it comes to investing, it is recommended to construct your investment portfolio as diverse as possible. A diversified portfolio is the first step to effective risk mitiga-tion. It is recommended to invest in that debt fund which has appropriate allocation to various money market instruments, instead of concentrating on single debt security.
Professional Management
Instead of individually selecting a debt security for investment, it is advisable to in-vest in a debt fund, where a professional fund manager formulates a portfolio of mul-tiple securities, after proper analysis of market sentiment and interest rate move-ments.
FAQ
- Financial Objective of the Investor
One should select the debt fund as per his/her financial goal. If you’re looking for av-enues to park idle cash for a short term, liquid funds are the best choice. If you want to save to meet a short term financial goal such as buying a car, or education ex-penses, you can opt for medium to long duration debt funds. - Investment Horizon
If you have an investment horizon of around 3 months to 1 year, it is advisable to in-vest in liquid funds. If the tenure of investment is more than 1 year and less than 3 years, you can opt for short term debt funds. Medium to long duration debt funds are recommended to investors with investment horizon of more than 3 years. Maturity pe-riod of the portfolio is also an important parameter for selecting the best debt fund for you. - Risk Appetite
Debt funds are not entirely risk-free. Credit risk and interest rate risk are quite preva-lent in these funds. Credit risk arises when the portfolio consists of securities with low credit rating. Whereas interest rate risk arises when any change in interest rate negatively affects the prices of the bonds. It is advisable to carefully analyse the fund’s historical performance and portfolio allocation, to get an idea of risk exposure of the fund. - Expense Ratio And Exit Load
Compared to equity mutual funds, returns from debt are quite low. Because of this, it becomes highly important to invest in a fund which has a low expense ratio. Also, some debt funds also charge an exit load to prevent premature withdrawal from the fund. This should also be taken into consideration before picking up the right debt fund for investment.
- Risk averse investors who are looking to park their money either for short term to earn decent returns (preferably more than savings account), or invest for 3-4 years can opt for debt mutual funds for investment.
- Debt funds are recommended to conservative investors who don’t want to place a bet on equity funds. Investment in debt funds ensures that your money is invested in safe financial instruments that are going to deliver fixed returns at maturity.
- Investors looking for an alternative investment option to fixed deposits, but with high liquidity can opt for debt funds. Unlike bank fixed deposits, debt funds don’t have any lock-in period.
- If you wish to earn stable returns, although smaller when compared to those from equity funds, you can consider the aforementioned debt funds for invest-ment.
