Why invest in a debt fund?

Life is all about finding the right balance. Be it your personal and professional life or your expenses and savings, maintaining a balance can always be rewarding. Striking the right balance holds for your investments as well. So, what does a balanced investment portfolio look like? Well, it's all about diversity. An investment portfolio with a mix of both equity and debt funds can help you gain better returns, thereby ensuring financial stability. While investors can maximise their returns with equity funds, having debt funds in their portfolio can help mitigate the risk associated with their investments. Let’s have a closer look at what are debt funds and why should you invest in debt funds.

What is a debt fund?

A debt fund is a mutual fund scheme that invests in fixed income generating securities such as corporate bonds, commercial papers, certificate of deposits, government securities, and other money market instruments. A debt fund is considered to be less volatile than equity funds, and hence it is suitable for investors with low risk appetite and who are looking for stability in their investments.

Top reasons to invest in a debt fund

Here’s why you should consider making debt funds a part of your investment portfolio:

Relatively Steady returns: Since debt funds are less sensitive to market volatility as compared to equity funds, investing in debt funds can help you generate comparatively stable returns without being as risky as equity funds. While they may not generate as high returns as equity funds, you can add stability to your investment portfolio with the help of debt investments.

Liquidity: Debt funds do not come with a lock-in period and you can redeem them anytime at your convenience. Due to their liquidity, investing in debt funds can help you build an emergency fund to deal with any unexpected financial crisis.

Stable income: Just like other schemes, with debt funds too, you can withdraw regular income. You can opt for Systematic Withdrawal Plan (SWP) to withdraw money by selling units from the funds.

Who should invest in a debt fund?

Here are some types of investors who can consider investing in debt funds.

Conservative investors

Investors with a low risk appetite who wish to minimize the risk of losing their capital can consider investing in debt funds.

New Investors

Since a debt fund is a comparatively low-risk investment, new investors can start their investment journey with debt funds before moving on to equity funds that bear relatively higher risk. This can help new investors gain relatively steady returns without being too concerned about market volatility.

Short-term investors

Instead of keeping surplus funds in a regular savings account, short-term investors can consider investing in debt funds for comparatively better returns without compromising on liquidity.

Medium-term investors

Debt funds usually earn better returns than traditional investment options such as Fixed Deposits (FDs). However, while FDs have assured returns, the same is not available in debt funds which are subject to market volatility.

Things to consider before investing in debt funds:

Fluctuating interest rates

Debt funds respond inversely to the changes in interest rates. Thus, a rise in the interest rate may decrease the returns, and vice versa. However, investors have the flexibility to enter and exit the fund at their convenience.

Credit quality

Debt fund holdings are disclosed basis the credit ratings given by the agencies – AAA, AA+, A1+, etc., and investors can choose funds based on this. It’s preferred to opt for a fund that has the most high-quality bonds but also do detailed research before investing in funds with lower rating.

Expense ratio

It’s important to consider the expense ratio prior to investing in a debt fund. If a debt fund yields 8% returns, investors won't receive the entire amount since the Asset Management Company (AMC) deducts costs including operational expenses and other overhead charges. Also, the actual value at time of redemption should be considered. It's advisable to choose a fund with a low expense ratio wherever possible. To sum it up, careful choice of debt funds can help you with capital appreciation and modest returns over a period of time. However, it is advisable to seek the help of a financial advisor to make an informed decision regarding your investments.

FAQs:

How to invest in a debt fund?

You must carefully analyze your risk appetite, financial liabilities, investment time horizon and financial goals to choose the right debt funds that suit your investment portfolio.

Is it possible to get guaranteed returns with debt funds?

Although debt funds are less volatile than equity funds, they do not promise guaranteed returns. This is because debt funds also carry credit risks, interest risks, duration risks and liquidity risks.

Which is better – equity or debt funds?

Both equity and debt funds have their own pros and cons. While equity funds can help you earn better returns and build a corpus, debt funds can keep your investment fairly stable against market volatility and may help you meet your short-term goals.

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 an 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