Before you make a valuable investment in debt funds, it is important that you know what debt funds are. A debt fund is a pool of investment just like an exchange-traded fund or a mutual fund. Debt funds invest in fixed income investments such as corporate bonds, Treasury Bills, Government Securities, and Money Market Instruments. The basic reason for investing in a debt fund is to earn capital appreciation and interest income. Some of the most popular debt funds include Dynamic Bond Funds, Income Funds, Short term and ultra-short term debt funds, Liquid debt funds, Gilt Funds, Credit Opportunities Funds and Fixed Maturity Debt Funds.
Here are 8 Reasons why you should make an investment in debt funds
Life is unpredictable. You never know when a financial emergency arises. When you are faced with a financial emergency more than often you need money at short notice. It is ideal to invest your money in debt funds to combat such critical scenarios. They are highly liquid, and they act as an emergency reserve. Debt funds can be easily redeemed at will anytime, and within a day your money gets credited to your linked bank account. Usually, debt funds don’t have redemption charges associated to them after a period of one month. With debt funds, you also have the option to make partial withdrawals without breaking your entire amount of investment.
Low on risk
If you invest in debt funds, then it reduces the risk of losses because debt funds are less volatile in comparison to equities. Debt funds are ideal for conservative investors who are looking for a regular income, however, are risk-averse.
If you wish to maintain a well-diversified investment portfolio, then you must invest in debt funds. Debt funds are very stable investment instruments when compared to highly volatile equity funds. The presence of debt funds in your investment basket along with equity funds substantially reduces the overall investment portfolio risk. They are quite the risk balancing component of any investment portfolio.
Debt funds are fixed income havens. They are the ideal investment instruments for investors looking for investments that generate regular income. You can generate regular income from debt funds through the dividend payout option or by opting for a Systematic Withdrawal Plan (SWP). SWP is the reverse of SIP. SWP allows you to make withdrawals of a fixed sum of the amount of capital appreciation regularly from your large pool of investment.
If you have set financial goals or targets which you want to accomplish within a short timeframe say within one or two years, then the best place to park your hard earned money is debt funds. Debt funds are less risky, highly liquid and stable income generators. They have predictable returns associated with them. This helps you plan and achieve your financial goals.
The debt fund market has a variety of debt fund investment options regardless of the time horizon. You can invest in liquid debt funds for a short period of less than 3 months. Liquid debt funds are a great alternative to the savings bank account as they generate stable income and are highly liquid. You can also choose to invest in ultra-short bond funds for a period of 3 months to 1 year. Short term bond funds with a time horizon of 1 to 2 years can also be opted for. Medium term debt funds come with a time horizon of 2 to 3 years while long term debt funds have a time horizon of 3 to 5 years. The longer the time horizon of the debt fund, the higher is the risk and the return on the investment.
Opportunity to park short term surplus
Unlike equity funds that are highly volatile in the short run, some of the debt funds offer retail investors the opportunity to park their surplus funds for a short time frame and earn a decent income on it.
Debt funds are more tax efficient when compared to other investment instruments. Only the capital gains on the debt funds are taxable. If the capital gain is made during a period of less than 3 years, then it is termed as Short-Term Capital Gain (STCG). However, a Long-Term Capital Gain (LTCG) is when a capital gain is made for over a time horizon of 3 years. You have to pay taxes as per your income slab. In the case of STCG from debt funds, a fixed 20% tax is levied after the application of indexation.
When you choose to invest in debt funds, there are a couple of factors that you must keep in mind. Some of them include the market environment, expense ratio and exit loads, and your current asset allocation and risk tolerance. Before you invest in debt funds, you must assess and evaluate whether or not a particular debt fund in question fits your investment objectives. Some of the crucial factors you must look into are the maturity profile of the debt fund, yield to maturity of the debt fund, the credit rating, the investment strategy of your portfolio, and portfolio duration. If you choose your debt funds correctly, they are the best way to counter equity market volatility.
If you have not added stability to your investment portfolio yet then its high time you expand your investment horizons, invest in debt funds and savor the flavor of a well-diversified investment portfolio and regular incoming income.