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ESG
When considering market investments, you may often hear about equities, stocks, and bonds. However, there is another crucial component many investors consider - debt funds. So, what is debt? In financial terms, debt is the money availed by an entity, which it assures to repay within a specific time period along with interest constituent. When you invest your surplus funds in a preferred debt mutual fund, you are basically lending your funds to borrowers in exchange for interest earnings.
Let’s understand what a debt fund means, what are the debt investment types available in the market and how to invest in debt funds for required corpus creation.
What is a debt mutual fund?
Ever wondered what a debt fund is? These are investment avenues generally preferred by low-risk investors looking for capital preservation.
Debt mutual funds are a type of mutual funds that invest primarily in debt securities such as government bonds, corporate bonds, commercial papers, and other fixed-income instruments. These funds aim to provide stable debt fund returns compared to equity funds, which are more volatile.
A few common types of debt mutual funds are -
Liquid funds
Ideal for short-term investments, they invest in short-term market instruments like treasury bills. They are known for quick liquidity.
Short-term and ultra-short-term funds
These funds invest in securities that mature in a short period. They are suitable for investors looking for a horizon of a few months to a year.
Gilt funds
Exclusively invested in government securities, they are considered safe but can be affected by interest rate movements.
Fixed maturity plans (FMPs)
These are close-ended debt funds with a fixed maturity date. They invest in instruments whose duration matches the fund's maturity.
How to invest in debt funds?
If you are interested in investing in debt funds, here are some factors to consider :
Understand your investment horizon
Before you delve into investing in debt funds, ascertain your investment horizon. For instance, if you are looking for a short-term parking space, liquid funds might be apt. Conversely, for a longer horizon, dynamic bond funds can be considered.
Consider the interest rate scenario
Debt fund returns are influenced by interest rate movements. If rates are expected to fall, longer-duration funds might be beneficial. Conversely, if rates rise, short-term funds could be safer.
Evaluate credit quality
Look for debt funds that invest in high-quality securities, denoted by ratings. AAA-rated bonds, for instance, are considered the safest. However, with higher returns, there might be higher risks, as seen with lower-rated bonds.
Check past performance
While past performance does not guarantee future results, it gives a glimpse of the fund manager's capabilities. Examine the debt mutual funds’ returns over a period of time and compare them to relevant benchmarks.
Risk appetite
Different debt funds carry varying risk profiles. For instance, gilt funds, though secure, are susceptible to interest rate risks. Knowing what a debt investment is and aligning it with your risk tolerance level is essential.
Review the expense ratio
This represents the annual fees charged by the fund house. A lower expense ratio can help enhance net returns, but it should not be the only deciding factor.
Return expectations
Set realistic expectations. High debt fund returns usually come with higher risks. It is vital to find a balance between risk and returns.
Fund manager's expertise
The competence of a fund manager is paramount. Their strategies, experience, and track record can significantly impact fund performance.
Fund house reputation
Opt for fund houses known for transparency, consistent performance, and robust management.
In conclusion
Understanding the meaning of debt funds and how they function can offer a safety net in volatile times. They present an attractive avenue for stable, albeit generally lower returns compared to equities. However, as with all investments, a well-researched approach that takes one’s financial goals and risk appetite into consideration is paramount before investing in debt mutual funds.
Disclaimer
The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.