Thinking of investing in debt funds? Every individual should have the right mixture of gold, debt funds and real estate in his/her portfolio along with some equity exposure. However, proportions for every asset will vary for individuals, depending upon their age, income, financial goals and risk appetite among other factors. Yet, every person should have exposure to fixed income-based assets such as debt funds. Senior citizens should allocate a higher chunk of their portfolios for debt funds in comparison to youngsters who have just started earning. Amongst young professionals, conservative investors should invest a higher proportion in debt funds as compared to those who have a higher risk appetite and wish to invest more in equity funds. The thumb rule clearly states that you should allocate a proportion of the investment portfolio that is equal to your age for fixed income assets such as debt funds.
Those who are new investors may also begin with these types of funds. Along with the expense ratio and other factors, you should also carefully understand the nature of a debt fund and how it basically functions. Any debt fund will be investing in securities which generate fixed interest including government securities, corporate bonds, treasury bills, money market instruments and commercial paper. The key reason behind investing in these funds is earning interest income steadily along with ensuring higher capital appreciation. Issuers of debt instruments will be pre-fixing the rate of interest that you will get along with the period of maturity. These are hence called fixed-income securities. These funds invest in a variety of securities on the basis of their credit ratings. The credit rating of any security indicates the risks of defaults for disbursal of returns that were promised by the issuers of debt instruments. The fund managers ensure that investments are made in credit instruments with high ratings. The higher rating indicates that the entity has a higher chance of paying up interest regularly on the debt security while repaying the principal at maturity as well.
A debt fund which deploys an investment in securities with higher ratings will have lower volatility in comparison to low rated market securities. Also, the maturity will depend upon the investment blueprint of the manager of the fund and the interest rate trends in the mainstream economy. The falling rate scenario will spur fund managers to buy long-term securities while a rising rate scenario will make them invest more in short term securities. These mutual funds have lower risks as compared to equity funds although the returns are comparatively lower as well but consistent. Debt-based funds will have short term maturity periods up to 91 days and several investors use them for meeting their short term goals/objectives too.
Why should debt funds be considered for your portfolio?
There are several reasons as to why debt funds may be a great choice for your portfolio. Firstly, they have shorter maturity periods, helping you enjoy more liquidity which will be handy during any cash crunch. You can balance out the liquidity quotient of your investment portfolio through these funds. Most of these funds come without any exit loads and you will not have to bear any penalties for instant withdrawals likewise. Secondly, these funds are highly suitable for meeting all short term objectives and goals. Investments in debt will be ideal for meeting goals that come after 10-12 months on an average of around 1-2 years at the most.
These investments have lower risk ratios as compared to their equity counterparts. Since they deploy investments in fixed-income generating securities, investments have far lower risks overall. Those who are conservative investors with lower risk appetite may consider investing in these funds which will grow at lower but steady rates. These funds are suitable for making lump sum investments too, as a result. Flexibility is greatly ensured with these funds and you can always invest through systematic investment plans or SIPs. It is a fully electronic and simplified procedure of transferring money to your debt fund from your bank account. You will only have to inform your bank and the pre-fixed amount will be debited from your account each month accordingly. You can also modify and increase monthly SIP amounts in the future, depending upon a rise in your income.
You can make investments either via dividend options or growth options. The latter means that investors will remain invested in these funds for the long haul. It will also scale up the NAV (net asset value) over a sustained duration likewise. However, if you are investing with an aim towards getting returns at periodic or regular intervals, then you should choose the dividend option. The returns will not be reinvested in this method and they will instead be paid out to you through dividends or bonuses.
The core take-away- Who are debt funds suitable for?
Debt funds are hence suitable for investors who are more averse to risks and want capital gains for covering goals in the short term. Yet, you should not invest all your capital in these funds and make sure that you diversify your portfolio with some equity exposure at least for balancing out the returns. Your investment strategy should be guided solely by your financial position and objectives down the line. Although these funds have lower risks, they are not fully free from any market volatility and fluctuations. Hence, beginners should carefully consult professionals and get proper advice before starting debt fund investments. You should lower risks by investing in funds owned by reputed and time-tested entities while also tracking the performance of the fund over the years along with checking the size, the track record of the fund manager, investment objectives of the fund, risk profile carried and past market performance.
On a closing note
Debt funds are ideal for investors with both medium and short term horizons for investments and those preferring investments in safer financial avenues without higher risks or volatility. Short term here will mean a period between 3 months and 1 year while medium-term will mean durations between 3-5 years on an average. Debt fund returns are mostly consistent and predictable so they are suited for retirees, senior citizens and those willing to make lump sum investments as well.