Debt funds are an investment option for investors looking to add stability and steady returns to their portfolios. They invest in fixed-income securities like government and corporate bonds, treasury bills, certificates of deposit, etc. Based on the maturity period of the protection they invest in, they can be categorized into short-term and long-term debt funds. Aligning your debt fund investments with your financial goals is crucial. Wondering what a debt fund is and how to go about it? Read on.
What is a debt fund?
Debt funds are mutual funds that invest predominantly in fixed-income securities like government and corporate bonds, money market instruments, treasury bills, certificates of deposit, etc. Based on the maturity period of the debt instruments they invest in, debt funds are categorized as short-term, medium-term, and long-term debt funds. They offer stable returns with lower volatility than equity funds by investing in debt instruments that provide regular interest payouts.
Short-term debt funds provide liquidity and stability.
Short-term debt funds invest in the money market and debt instruments with a maturity period of up to 1 year. The short duration provides liquidity, while the diversified portfolio ensures stability of returns. Short-term funds usually deliver slightly higher returns than savings accounts or fixed deposits, ranging between 5% and 8% per annum.
Short-term debt funds are suitable for goals of up to 3 years. They can be used to build an emergency corpus, save for a vacation or child’s education, or make a down payment for a house. Short-term funds can also provide periodic income through Systematic Withdrawal Plans (SWPs). With low to moderate risks and easy liquidity, short-term debt funds align well with near-term financial needs.
Long-term debt funds for wealth creation
Long-term debt funds invest in government and corporate bonds, state development loans, etc., with maturity periods usually above five years. Long duration helps optimize returns over the long run. Long-term debt funds in India have delivered annual returns between 8-9% over the last 5-10 years.
Long-term debt funds are meant for goals with a 5-year or longer time horizon. They are ideal for retirement planning, children’s marriage, accumulating a targeted corpus, etc. Long-term funds have relatively higher volatility and lower liquidity. But their power of compounding makes them a rewarding wealth-creation tool for patient investors. SIPs in long-term debt funds help accumulate a large corpus through compounding.
Choose between active and passive long-term debt funds.
Long-term debt funds in India come in two categories – actively managed and passively managed index funds. Actively managed funds rely on the fund manager’s security selection and timing expertise. They try to outperform the market benchmarks by taking some additional risks. Index funds mimic a designated debt index like the Nifty Bond Index, which has lower costs but no active fund management. Evaluate your risk appetite and expected returns to decide between active and passive long-term debt funds.
Assess your risk appetite.
Debt funds carry lower risk than equity funds, but some risks exist. Interest rate changes impact bond prices and debt fund NAVs. The longer the maturity period, the higher the interest rate sensitivity. Credit risk or default risk also needs consideration. Evaluate your risk appetite and investment horizon before deciding between short and long-term debt funds.
Review portfolio periodically
Review your debt fund investments periodically to ensure they continue to match your goals. Redeem short-term funds if goals are achieved earlier. Switch to safer debt funds as the goal deadline approaches. Align long-term investments with changes in time horizon or risk profile. Make changes if required, keeping taxes and exit loads in mind. Proper asset allocation across equity, debt, and other assets is key. Seek advice from qualified financial advisors to construct a balanced portfolio aligned with your financial goals at various life stages.
Conclusion
Before investing in mutual funds in India, especially debt funds, evaluating factors like investment horizon, liquidity needs, risk tolerance, and expected returns helps identify suitable short-term and long-term funds. Aligning investments with changing financial priorities ensures debt funds contribute effectively to achieving your financial objectives. Periodic reviews and portfolio rebalancing help maintain the alignment over time.