Debt mutual funds: Reasons to consider debt funds for your portfolio this financial year

Investing in mutual funds requires careful planning and strategy. There are multiple mutual fund categories available, and choosing one that aligns with your needs and preferences is essential.

For instance, investors seeking the potential to build wealth in the long term may find equity mutual funds appealing. However, for investors who are seeking relative stability and lower risk, or those who have a shorter investment horizon, debt funds may be more suitable.

As we head into the new financial year, it is a time to evaluate your finances and make adjustments if necessary. One option that investors can consider is debt mutual funds.

This article explains in detail what debt mutual funds are, how they work and the advantages they offer. It also offers a step-by-step approach to investing in them. Whether you are a seasoned investor or just starting, this guide can help you make informed decisions.

• Table of contents

1. Brief definition of debt mutual funds
2. Reasons to invest in debt funds
3. Who are debt mutual funds suitable for?
4. Step-by-step guide to invest in debt funds

Brief definition of debt mutual funds

Debt mutual funds are investment options that focus on fixed-income securities such as government bonds, corporate bonds, treasury bills, and other money market instruments. These funds aim to provide relatively stable return potential over long term with relatively lower risk. In contrast, equity funds invest in company stocks, aiming for higher returns in the long-term but come with relatively high risk of volatility.

Debt funds are thus suitable for investors who prioritise relative stability of capital and the potential for steady income. However, debt funds are not risk free. Their performance is influenced by factors including,but not limited to, interest rate movements, the credit quality of the bonds they invest in, and overall market conditions. At the same time, they tend to see relatively less fluctuation than equities.

Reasons to invest in debt funds

Relative stability: Debt mutual funds invest in fixed-income securities like government and corporate bonds. This gives the potential for relatively stable returns compared to more volatile equity funds.

Lower risk: Since these funds invest in debt instruments, they carry relatively lower risk than stocks, making them a more suitable option for conservative investors.

High liquidity: Unlike fixed deposits, which come with a lock-in period, debt funds like liquid funds offer higher liquidity. You can withdraw your money whenever needed.

Diversification: Adding debt funds to an equity-oriented portfolio may help balance risk and mitigate the impact of market fluctuations.

Who are debt mutual funds suitable for?

Debt mutual funds may be suitable for the following categories of investors:

• Conservative investors: If you prioritise relative stability of capital over high returns, debt mutual funds can be suitable. They provide predictable returns with relatively lower risk, making them suitable for risk-averse investors.
• Short to medium-term investors: For those planning to invest for a short or medium term, debt funds can be suitable as equity funds can be highly volatile in the short term.
• Retirees and senior citizens: Debt funds provide the potential for regular income, making them a suitable choice for retirees looking for an income stream.
• First-time investors: Beginners who are hesitant to invest in the stock market can start with debt mutual funds. These funds help them understand market dynamics while offering a relatively less volatile investment journey.

Step-by-step guide to invest in debt funds

1. Define your investment goal
Before investing, determine your financial goal. Are you looking for short-term returns, potential for regular income or relative stability? Understanding your objective helps in choosing the right debt fund category.

2. Choose the right debt fund category
Debt mutual funds are classified based on their investment horizon and risk profile. Some common types include:

• Liquid funds: Suitable for very short term investments or for parking surplus cash
• Ultra-short duration funds or short-term funds: Suitable for short-term goals.
• Corporate bond funds: Invest in high-rated corporate bonds for relatively higher return potential with slightly increased risk.
• Gilt funds: Invest in government securities and offer minimal credit risk

3. Compare different funds
Look at different schemes along the following parameters:

• Past performance: Check the fund’s historical returns but note that past performance may or may not be sustained in the future.
• Expense ratio: A lower expense ratio translates to higher net returns.
• Credit quality: Funds investing in higher rated securities carry lower risk.
• Interest rate sensitivity: Funds with longer durations are relatively more sensitive to interest rate changes.

4. Choose an investment platform
You can invest through various routes including:

• Directly through the Asset Management Company managing the mutual fund
• Registered mutual fund distributors
• Aggregator platforms
• Banks
• Registrar and Transfer Agents

5. Complete KYC (know your customer) process
To invest, complete the KYC process by submitting your PAN card, Aadhaar card and bank details.

6. Invest and monitor
Decide whether to invest in a lumpsum or through a Systematic Investment Plan (SIP). Regularly monitor the fund’s performance and market conditions to make informed decisions.

Conclusion

Debt mutual funds can be suitable for individuals seeking the potential for relatively stable returns with lower risk. Whether you are a conservative investor, a retiree, or someone looking for diversification, debt funds can find a place in your portfolio. By understanding the types, benefits, and risks associated with these funds, you can make informed investment decisions.

FAQs:

What is meant by a debt mutual fund and how does it work?

A debt mutual fund is an investment vehicle that primarily invests in fixed-income securities like bonds, treasury bills and money market instruments. These funds seek to generate returns through interest earnings, making them a relatively stable investment option compared to equity funds.

Is a debt fund investment better than FDs?

Debt mutual funds and fixed deposits (FDs) serve different purposes. FDs offer guaranteed returns with a fixed interest rate and are considered safe. However, they are not liquid and pre-mature withdrawal incurs a penalty. Meanwhile, debt funds offer high liquidity. Their return potential can be relatively higher than that of fixed deposits of the same duration in favourable market conditions. However, they entail some risk. Returns are not fixed or guaranteed.

What are the risks of debt funds?

Although debt mutual funds are lower risk than equity funds, they do carry some risks:

Interest rate risk: The market value of debt funds can fluctuate based on changes in interest rates. If interest rates rise, bond prices may fall, affecting returns.

Credit risk: Debt funds invest in bonds issued by companies and the government. If an issuer fails to repay the debt, it can impact the fund’s performance.

Liquidity risk: In certain situations, especially during market downturns, some debt funds may find it difficult to sell their securities quickly, which could delay withdrawals.

Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.