Things To Keep In Mind While You Choose A Debt Fund
Mutual funds are investment tools in which your money is pooled with the contributions of other investors. Once enough money is collected in the fund, it is used to purchase different financial securities such as bonds, stocks, money market instruments, and gold. By buying a unit in a mutual fund, you get to own a small stake in all the investments considered to be a part of the fund. Thanks to the numerous advantages that are associated with mutual funds are considered by many investors a prudent investment choice.
This investment scheme essentially functions as a trust that collects money from you and other like-minded investors. AMCs i.e., asset management companies are known for operating and managing mutual fund schemes. However, it is important to note that mutual fund schemes are not a monolith. There are numerous types of mutual funds that are available and each of these schemes are known for coming with a specific investment objective that caters to distinct investment needs. One of these many mutual fund variants is debt funds.
What are debt funds?
Debt mutual funds are known for being the type of mutual funds that primarily allocate funds to debt and other money markets instruments such as commercial papers (CPs), treasury bills (T-Bills), and certificates of deposits (CDs). Examples of debt market instruments include things like government bonds or G-Secs and non-convertible debentures (NCDs).
The main aim behind allocating funds to assets like debt or money market instruments is to enjoy stable income in form of interest payments. What differentiates this type of mutual fund from an equity fund is that debt funds are known for having considerably lesser risks in comparison. Apart from that, there is another major difference. The said difference between the two is that there are variants of debt funds that can help you invest even for one day or a few months. For example, overnight funds are the variant that invests in instruments that mature overnight. Another type of debt fund, namely, a liquid fund is known for allocating funds in securities that mature in less than 91 days. But, before being swayed away by the several benefits offered, there are some things you need to remember about debt funds. Listed below are the things you need to remember before you go ahead and opt for a debt mutual fund.
Things to remember while choosing a debt fund:
- What is the maturity and duration?
Bond prices and interest rates are known for having an inverse relationship in general and fluctuations in interest rates are known for having an impact on debt mutual funds. A modified period essentially serves as price sensitivity of debt funds to the interest rate changes. The longer the adjusted period is of a debt fund, the more vulnerable the scheme is to interest rate increases.
- What is the expense ratio?
The expense ratio can be defined as the sum of all the expenditures incurred in the operation of the debt fund scheme. As debt funds’ return or upside potential is considered small, the expense ratio is regarded as more critical than equity mutual funds. A direct plan should be the preferred option for investors who have a low-cost ratio. After considering the cost ratio, you can calculate the returns from debt funds. For example, if the return on a debt fund is 9% and the cost ratio is 1.5%, the return made by the investors would be just 7.5%.
- What is the estimated return?
Also referred to as the yield to maturity, it is the estimated return in case all the investors held on to the securities in the portfolio until maturity. For example, if a fund’s yield to maturity is 9%, you will gain 9% if the portfolio stays unchanged until the maturity of the portfolio. However, it is important to make note of the fact that the yield to maturity is not a reliable indicator of returns in case the fund manager is known for using aggressive portfolio management.
Debt funds are known for offering things like consistent income, low risk, relatively predictable returns, and high liquidity. The feature of indexation, which is available after three years in the case of debt funds allows for tax-efficient investments.