Debt funds are the mutual funds that invest a majority of the invested sum in fixed income securities depending upon the investment horizon and the income priorities of the investor. Some of the instruments debt funds invest in are money market instruments, corporate bonds, and treasury bills and commercial papers, etc.
The main aim of this class of assets is to invest in fixed income securities that allow investors to earn interest income and gain capital appreciation. The securities are issued at a face value and at maturity the issuer is obliged to buy back these securities by paying interest. The interest paid to the investor is specified beforehand by the issuer.
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Currently, the equity funds are underperforming and long term debt funds are offering better returns than equity mutual funds in the 1-year investment horizon. However, you must not consider that debt funds will always over perform equity funds. The past performance of equity funds has proven that it has the potential to beat all asset classes when invested for a longer period thus generating inflation-beating returns.
It must be kept in mind that debt funds cannot outperform equity all the time. So it is not worthy to chase only better-performing assets. Recently, the long term debt funds are making profits due to the interest rate regime as the RBI has introduced rate cuts. However such schemes may be badly affected when the interest rate regime changes when the RBI will hike the interest rates.
See Also: What Are Debt Funds?
Debt fund should be your first choice if you are not comfortable to take a risk or are not yet ready for equity exposure. Through a debt mutual fund, you can grow your wealth with minimal risk.
You do not need to actively operate it or check your investment on a regular basis. The reason is debt funds have a short to the medium investment horizon. If you have a short investment horizon you can remain invested for 3 months to 5 months whereas for investors with mid-term investment horizon you can remain invested for investment tenure of 3 to 5 years.
These investments allow you to maximize your returns by diversifying your money across different types of securities. This way you can yield moderate returns as well as ensure the liquidity of your deposits. The returns from debts funds can be predicted and thus it is a safe investment option for traditional investors who wants to secure their deposits and are risk-averse.
Though debts funds offer a safe investment avenue to investors, it is worthwhile to consider the following points before investing in such investment instruments.
These funds are aimed at earning better returns by diversifying your portfolio across several types of securities. Since the returns fall within a predictable range you can stay assured about the returns that can be generated. This allows conservative investors to opt for debt funds
There are several categories of debt funds from which investors can choose. Liquid funds, fixed maturity plan, dynamic bond funds, income funds, monthly income plans, GILT funds, short-term funds, and ultra-short-term funds are all different categories of debt funds.
These funds are exposed to several types of risks like credit risk, interest rate risk as well as liquidity risk. Liquidity rises arises when the fund manager fails to sell your security due to a decline in their demand. Investors may counter credit risk when the issuer of such funds fails to meet its obligations. There can be a change of fund value due to the shift in the overall interest rate.
See Also: Liquid Funds vs Debt Funds
Since these funds are actively managed, investors are required to pay a fee to fund managers to manage their investments. The expanse ratio of debt funds is mandated by SEBI. A long holding period may help you recover the money paid as a fee to the fund manager.
Debts funds can prove to be an additional source of income and you can make such investment if you want to accommodate a second income along with your primary income. You may also invest in debt funds if you are a beginner and want to avoid the risk posed by equities. Debt funds also help to maintain the liquidity of your funds. It is also an ideal option for retirees who can invest a lump sum in debt funds and use it to receive a pension.
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