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When To Choose Debt Funds If Planning To Invest

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As of now, there are 16 debt fund categories in the Indian mutual fund scheme with more than 300 different schemes to choose from. For someone who is new to investing, this can be a bit overwhelming, and hence, investors should consult a financial advisor to make an informed investment decision. You do not want to invest in a scheme whose investment objective does not align with yours as this will only increase your portfolio’s overall risk.

If you planning to build an investment portfolio with mutual funds, then it is essential to add debt mutual funds.

Make the right investment decision

Before choosing a debt scheme for your mutual fund portfolio, investors need to understand their risk appetite and investment horizon. Some assume that debt funds are only good for the short term. That is not true. Of course, we have schemes like liquid funds, overnight funds, ultra short term funds, etc. that have a short average portfolio maturity. However, there are other schemes like gilt funds, medium duration funds, long duration funds, etc. whose average portfolio maturity may span over five to ten years. Hence, investors need to first identify the reason behind investing and only then choose a debt fund.

Understanding credit ratings

Debt securities are rated by rating agencies like CRISIL. These debt instruments are rated to determine the issuer’s creditworthiness. For example, debt funds that invest in AAA+, AA+ or similar credit ratings are less likely to find themselves at default risk. However, debt instruments with a C or similar ratings have very high default risk. Having said that, debt schemes that invest in safe debt instruments may not be able to generate yields like those debt funds that invest in debt instruments with high credit risk. That’s because instruments that are at risk have the potential to generate higher returns. On the other hand, debt instruments with good credit ratings are relatively safer but will generate low returns.

How much of my portfolio should consist of debt funds?

Every individual’s investment portfolio is unique, and it is recommended that you do not try to mimic the investments of others as their financial priorities will vary from yours. Also, the risk appetite, investment horizon of others will not be the same as yours and hence, your investment portfolio should be unique and must be made tailor-cut to suit your financial goals. When investing in mutual funds it is essential to try and benefit from different asset classes. One should not bet all their money on only one scheme or only one asset class. Investors should seek diversification and invest in the right mix of equity, debt, gold, etc. The most generic mutual fund portfolio for someone with a high risk appetite is 75%-80% exposure to equity and the remaining 20%-25% to debt. This composition may vary from individual to individual depending on their current age, their existing liabilities, and the kind of risks they are willing to take to achieve their ultimate financial goal.

Debt funds form an essential part of a mutual fund investor’s portfolio as they can mitigate the portfolio’s overall investment risk. Also, it is impossible for all asset classes to perform in tandem all at once. If and when the equity markets turn volatile and your portfolio suffers, investments made in debt funds can offer the much needed cushion and reduce risk. Debt funds invest in fixed income generating securities, thus offering low but stable returns.

If you are planning to invest in mutual funds, make sure that you add debt funds to your portfolio.

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