4 Things To Consider Before Investing In Debt Funds

Most investors today prefer to invest in the investment market instead of bank fixed deposits. Of these mutual funds, specifically, debt mutual funds continue to remain a popular choice among various investors. As an investor, you can choose from a wide range of mutual funds, depending upon your financial goals and risk appetite. If you prefer to invest in securities generating fixed-interest, for instance treasury bills, government securities, corporate bonds and other such money market instruments, it is best that you invest in debt funds. However, before you invest your money, here are 4 things you should consider.

  1. The returns you can earn

No matter what type of investment instrument you choose, you have to consider the returns you can earn. Typically, we all want to invest in instruments that offer either fixed or high returns. Most people invest in debt mutual funds, because they are regarded as fixed-income havens. However, there is no real guarantee that you will earn returns on your debt securities investment. Remember, if the overall interest rate rises, then the NAV (Net Asset Value) of your debt investment fund, may fall. As such, if you wish to earn higher returns you must invest during falling interest rate regimes.

  1. Type of fund and investment horizon

Investors can choose from various types of debt mutual funds in India. These include long and short-term funds, liquid funds, dynamic bond funds, income funds, etc. However, just like you need to select the right type of fund to invest in, you should also consider the period for which you wish to stay invested. For instance, you should opt for liquid funds if you wish to exit the fund within 3 months to 1 year. If you can stay invested for 2 – 3 years (which is the ideal tenure for mutual fund investments), then it is better to invest in short-term bond funds. If you can afford to stay invested for tenures of 3 to 5 years, dynamic bond funds may be a good option for you. Remember you can get better returns if you opt for longer investment horizons.

  1. The risk of investing in the fund in general

In general, all kinds of share and mutual fund market investments come with an element of risk. If you choose to invest in debt funds, you have to consider the interest rate risk and the credit risk associated with it.  In case of interest rate risk, the prices of bonds may fall if the interest rate increases, whereas in case of credit risk, your fund manager generally invests in securities with low-credit ratings, which have higher default probabilities but may accrue high returns too.

  1. Your financial goals

Debt based mutual funds can provide you additional income; an amount that can exceed your monthly salary. This can help you fulfil your various financial goals too. You can invest a certain portion of your monthly income in liquidity funds to earn an alternative source of income. If you are a retiree, you can consider investing a part of your pension or provident fund in debt securities and earn additional income.

Apart from the above mentioned points, you must also consider the cost associated with investing in debt oriented funds and the taxes payable on investment gains. While you must pay an ‘expense ratio’ fee to your debt fund manager, you also have to pay taxes on the gains accrued, based on the period for which you choose to stay invested. The tax you pay depends on long and short term capital gains and the tax slab you fall in.

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