An ideal investment vehicle for conservative investors, debt funds invest primarily into fixed income securities such as corporate bonds, treasury bills and commercial papers, among others. The basic purpose of investing in these funds is to provide stability to the portfolio. However, there are certain things you must keep in mind before investing in this category of funds.

They aren’t wealth generating products

Debt funds shouldn’t be viewed as wealth generating products. When you invest in debt funds, you shouldn’t expect bumper returns from them. Their primary objective is to keep volatility at bay and cushion the portfolio from market fluctuations.

Note that they offer better returns than bank fixed deposits (FDs) and in some cases enjoy better taxability than over FDs.

Debt funds are alternatives to existing fixed income instruments

Debt funds can be alternatives to your existing fixed income instruments such as public provident fund (PPF), company PF, corporate or bank FD, etc. Instead of too much exposure to these products, you can choose debt funds, which not only offer better returns in the long run but also score high on the taxability front.

Note that barring PPF, interest from all the above is added to your income and taxed as per the existing tax slab. Debt funds, on the other hand, offer indexation benefit for long-term capital gains if held for more than 36 months or 3 years.

Debt funds too carry risk

There’s a common misconception among investors that debt funds are entirely risk-free. However, it’s not. Debt funds are exposed to a number of risks, including:
  • Market risk: Change in prices of the bonds held by debt funds can negatively affect its NAV. Long tenure bonds held by debt funds are highly sensitive to interest rate risks and funds investing in them carry higher market risks.
  • Default risk: Failure to pay back the interest or the principal held by the corporate entity exposes debt funds to default risks.
  • Credit risk: Sharp drop in NAV of debt funds as a result of poor corporate governance of the company invested results in downgrading of the bond ratings. When this happens, bond prices of good companies also get affected.

Returns from debt funds aren’t fixed

Debt funds aren’t bank fixed deposits which offer guaranteed returns. In other words, returns from debt funds aren’t fixed. Depending upon prevailing market conditions, their returns may vary. So, by investing in these funds, you shouldn’t expect guaranteed returns under any circumstances.
Just like investing in other categories of mutual funds, it’s essential to adopt due diligence before investing in debt funds. Check out the fund’s performance across market cycles before committing.

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The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.

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