2018 saw a significant rise in mutual fund investments in the country and this trend is expected to continue throughout 2019. With high returns and flexibility in terms of investment, mutual funds have become a preferred choice for many. There are many types of mutual funds one can choose from. Keeping investment goals in mind, it is important to identify the fund that is an ideal fit. The two major types of mutual funds include equity and debt. While an equity fund invests into the securities of different companies, a debt fund invests in fixed income securities like treasury bills and bonds.
Advantage Of Debt Funds
Highly preferred over fixed deposits due to liquidity, higher returns and tax efficiency, debt funds are giving competition to fixed income investment products for a number of reasons. Firstly, it is possible to withdraw money from a debt fund because it offers great liquidity.
There is a penalty associated with a fixed deposit but debt funds have no penalties in case of an early withdrawal. There are a few debt funds that have exit loads but if the investment tenure is correctly aligned with the period for which the fund charges exit load, the investor will be able to spare himself from the same. For short term investments, liquid funds are ideal because it has no exit loads.
There is higher flexibility offered by debt funds in terms of the amount of investment that can be made in one go. Additionally, there are a number of options to choose from based on the need for regular income and creation of wealth. The biggest advantage is the tax advantage. When debt funds are held for more than three years, they are highly tax efficient because the long term gains are taxed at the rate of 20% after adjusting inflation.
Risks On The Investment Path
Debt funds are expanding in assets and it is impossible for debt mutual funds to take complete losses of an investor. The assets under management in case of debt schemes have more than doubled in the last five years and the capital market regulators insist on passing forward the losses to the investors. There are many investors who made a shift from fixed deposits towards market-linked debt instruments as they were expecting higher returns but nobody informed them that the capital could erode in a debt fund as well.
Investors need to consider a few things before investing in debt funds. First and foremost, the debt mutual funds are not designed to make sure that an investor gets their money back in case of downgrading in the rating, delay in repayment or a default by the companies whose securities they have invested in.
Investors need to be clear that in case of any negative event, the net asset value of the scheme will erode to a certain extent. Here arises a question whether a debt fund is a fixed income fund. Again, the debt schemes offered by large fund houses will not ensure that investors get all their money back. Investors prefer top mutual funds because they think the money is safe there. However, there have been incidents where the big fund houses took a hit and their investment strategy did not work. A smaller fund house could exit the loan due to its size but a large fund could not exit from this situation.
Manage Risks Well
The trick is to choose the right type of debt mutual fund. It needs more assistance than equity and this is where investors need hand-holding. The focus of debt investment for companies is whether they would be able to repay the money to investors or not. Over the last few years, debt funds have gained popularity amongst the investors because of higher returns and better taxation.
However, investors need to decide why they want to put their money into a debt fund. Is it because of the safety net or higher returns? When the pitfall of debt mutual funds is compared with fixed deposits, the scores are leveled. When it comes to the returns generated by debt funds, it can be rightly said that it has outperformed equity funds lately. Due to a dip in the equity market, debt funds have benefited investors significantly.
The best way to manage risk is to ensure that the chosen fund aligns with the long term goals of an investor. Another aspect is risk analysis. An investor should evaluate the portfolio and identify the amount of risk he can take.
There are 16 different types of funds under debt funds and based on the profile of the investor and time horizon, one can choose the right fund. Investors looking to park their funds for a short period of time and to meet a specific goal will have to choose low duration or ultra short duration funds.
Even liquid funds and overnight funds are used to hold funds for a short period of time. For the short duration, preservation of capital is crucial. Then there are short duration funds which are ideal for an investor who wants debt funds to be a part of their asset allocation.
It is important to remain invested in the funds for two to three years. Investors who can take higher risk and look for higher returns should go for corporate bonds. Amateur investors should stick to short duration funds to keep their money safe and to generate higher post tax returns.
When buying a fund, it is important to look at historical returns but also evaluate the risks which the fund takes in order to generate additional returns. Taking higher risks may or may not translate into higher returns. Higher returns from investing in low rated paper can work well until there is a default. However, an investor should always align the risks and returns of the product with their personal requirements. There is no risk free investment, it is only the amount of risk that varies.