People usually invest in debt funds for short-term objectives. But what if you also need to put money into debt funds for long-term goals?
A 100 percent or all-equity allocation is not suitable for every investor. In reality, most long-term investors would benefit from having some debt in their portfolios. 60-80 percent equity and the rest 20-40 percent debt is typical.
An asset allocation-based strategy is ideal for most portfolios because it provides a balance of growth and stability.
So, where should this debt element of the portfolio be invested? But, before that, let’s understand what debt funds are.
What are debt funds?
Debt mutual funds in India, also known as fixed-income funds, are perfect for investors who want to make regular investments while avoiding risk. These funds are less volatile; thus, they don’t have the same investing market risk as other mutual funds. Debt funds are similar to traditional fixed bank deposits, except that debt funds offer higher yields and more tax advantages.
Regarding how debt funds work, they’re not all that different from other forms of mutual funds. On the other hand, debt funds score well in terms of safety and security.
Why should you invest in Debt funds?
Debt funds are the most risky, compared to standard FDs. A debt fund’s primary goal is to offer investors with stable income over the life of their investment horizon. As a result, you’ll need to choose a time horizon that matches the money.
You can learn about numerous debt funds and their durations directly from the fund houses, online, or through a third party. This will aid investors in comprehending a fund’s interest rate performance. It will also help you take advantage of market volatility by allowing you to make more informed judgments.
Here are the advantages of debt funds:
Fluctuating interest rates
Fixed investment securities react inversely to interest rates, and debt funds are fixed investments. If the interest rate rises, the debt fund’s returns will fall, and vice versa. Furthermore, the longer the debt fund’s maturity time, the greater the danger of interest rate fluctuations.
However, in order to achieve superior returns/capital appreciation, investors may need to maintain a long investment horizon. While debt funds are also susceptible to interest rate swings, they provide investors with greater flexibility in terms of entering and exiting the fund.
Debt funds are offered across the whole maturity and credit risk spectrum. Shorter-term funds produce consistent and reliable income. Longer duration funds generate income from both interest and capital gains, and they are suitable for investors who are willing to accept higher NAV volatility. Overnight funds, corporate bond funds, liquid funds, and short-term funds are all known for investing in the safest debt instruments. Credit risk may be taken on by ultra-short and short-duration funds in order to deliver higher returns.
Debt funds are highly liquid and can be redeemed quickly, usually within one or two working days of submitting the redemption request. There is no lock-in period, unlike bank fixed deposits or recurring deposits. While a few funds may apply a minor exit cost for early withdrawals, there are no penalties when withdrawing a mutual fund investment.
The amount of time an investor holds a fund impacts the tax benefits they obtain. Investors who have debt funds for less than a year may be subject to a short-term capital gains tax. A long-term capital gains tax of 20% will apply to debt funds held for more than a year, and indexation advantages will be included.
Before investing in a debt fund, it’s critical to think about the expense ratio. Because the AMC deducts expenses such as operation fees and other overhead charges, even if a debt fund generates a 10% return, the investor would not receive the entire amount. These are the mutual fund fee ratios that investors should check for when selecting a debt fund. It’s advisable to invest in a fund with a low expense ratio.
Debt funds are among the safest mutual funds on the market, with predictable returns, greater liquidity, and accessibility, making them among the most sought-after investment tools in the market, particularly among investors with a low-risk appetite. The key thing to keep in mind is to do your homework before starting your investment adventure and to look into the best-performing funds to get the best results.