An unfortunate yet common mistake that amateur investors are known for committing is directing all their funds into one kind type of financial security. Ideally, a diversified mutual fund portfolio will be considered will be fruitfulforyou. In simple words, this means that you will need to expose your funds to multiple asset classes, i.e., financial securities. Equitiesand debt are some of the prominent examples of asset classes. Debt is a market whereyou can place your funds to multiply your wealth. In case you arestartingyour investment journey, debt funds are a crucial segment. So, the debt must be a part of your portfolio. But before going into details of what you should remember before choosing a debt fund, you need to understand what a debt fund is and how they work.
What are debt funds?
Debt funds are known for being one of the best fund allocation options for you if you are searching foran investment scheme that comes with low-risk tolerance. That’s becausethese funds are not as volatile as investments in equity funds. But there are still some challenges. Generally, new investors often find themselves at crossroads when choosing a debt fund scheme that is best suited to their portfolio, financial goals, and requirements.
How do they work?
Debt funds are the type of mutual funds that are known for investinganinvestor’s money intofixed interest generating securities, such ascorporate and government bonds, debentures, and other types of money market instruments. These funds are also often considered safer in firm contrast to the volatility that characterises the equity market.Debt funds are known for coming with lower risk, but that also means that theyoffer lower returns unlike equity funds, which offer higher returns as a reward for the high risk taken by the investor. Debt funds are known forcoming with varying maturity periods and they can generate income either at maturity or periodically.
Things to remember while opting for debt funds:
Listed below are the things you need to remember before opting for debt funds:
- The interest rates are fluctuating:
As stated earlier, debt funds are fixed investments, and that means that fixed investment securities are known for reacting inversely to interest rates. Arise in the interest rate will lower the returns on the debt fund and vice versa. Moreover, the longer the maturity period for the debt fund, the more the risk of the interest rates fluctuating. However, you might also need to keep a long investment horizon to enjoy better returns or capital appreciation. While these mutual funds are subjected to the risk of interest rate fluctuations, they are known foroffering the investors flexibility duringthe entry and exit from the fund.
- There are indexation benefits:
The duration for which a fund is held is known for having an impact on the taxation benefits you receive. Debt mutual funds which are held for less than a year will incur a short-term capital gains tax for you. But, debt funds that are held for over a year will have a long-term capital gains tax of 20% and even come with indexation benefits.
- Expense ratio:
Before opting for a debt mutual fund, you must consider the expense ratio prior. If the debt fund you are considering were to yield 10% returns, you will not receive the entire amount. That’s because the AMC (asset management company) levies charges such as overhead charges and operating fees. These changes arethe expense ratio of the mutual fund that you will need to check before opting for a debt fund. It is recommended to choose a debt fund where the expense ratio is minimal.
Debt mutual funds are regardedas one of the safest investment options that are known to come with predictable returns, convenience, and increased liquidity.Thanks to the benefits mentioned above,these schemes have struck a chord with investors who have a low-risk appetite. But, before opting for these funds, you need to do thorough homework before beginning your investment journey before opting for these schemes.
