6 Factors to Look Out For While Choosing a Debt Fund

A mutual fund is an investment tool for those seeking capital gains over the long term. But a lot of people confuse mutual funds with only being equity oriented funds and hence, stay away considering equity investments are exposed to market volatility. But what many individuals do not know is that mutual funds are further categorized depending on various attributes including risk tolerance, investment strategy, investment objective, the maturity of securities, asset allocation, etc.

There are mutual funds catering to investors depending on their risk tolerance, investment horizon and investment objective. While equity funds might be the most sought after for their risk/rewards ratio if you do not have a high risk tolerance, you might want to consider getting to know more about debt mutual funds.

While equity funds invest predominantly in equity and equity related instruments, debt funds are those mutual funds which invest in marketable securities like treasury bills, call money, government securities, bonds, etc. that come with a maturity of up to 91 days. Several individuals even consider debt funds like Axis Short Duration Fund as an investment option to park their idle cash. Also, because these funds invest in debt instruments, they are considered to be a viable option (although not guaranteeing the same).

But choosing a debt fund may not be as easy as it seems. If you are a first time mutual fund investor, here are a few things to keep in mind while picking a debt fund.

1. Risk tolerance

Although debt funds are supposed to be less risky than equity oriented funds, there can be no claims made regarding the same. Before choosing a debt fund, the first question you need to ask yourself is ‘Am I willing to expose my finances to the risks associated with debt funds. There are two types of risks generally associated with debt funds – credit risk and interest rate risk. There are a few debt funds that invest in companies with a high credit risk rate. This may impact the fund’s NAV in the wrong way. Hence, make sure that you have the adequate risk tolerance for investing in debt funds.

2. Invest in a debt fund whose investment objective matches with yours

Understand that there are different types of mutual funds available for investors. So depending on what your ultimate financial goal is and the corpus you wish to achieve through investments, choose a debt fund that you think holds the potential to help you get closer to your financial goal.

3. Choose a debt fund managed by an experienced fund management

It is essential that the debt fund you are about to invest in is from a reputed AMC. Investing in a debt fund that is handled by reliable management is a better option. How a fund performs solely depends on the fund manager managing the fund. Also, a reputed AMC is usually equipped with all the necessary research and analytical tools which should add to its credibility. Hence, make sure that you invest in a debt fund that belongs to a reputed fund house and is managed by a professional and experienced fund manager.

4. Make sure that you invest in a debt fund with a proven track record

Remember that you are entrusting your hard earned money in the hands of the fund manager, and hence, it is essential to make sure that the debt fund you invest in has proven track record. It is better that you check the performance of the funds at various intervals one month returns, six months returns, three year returns, five year returns, etc. like Yes, it is true that just because the fund has a good track record, it may or may not continue providing similar returns in future. But it is better that you check the fund’s past performance while choosing the debt fund.

5. The expense ratio of the fund

Owing a debt fund comes at a cost which fund holders have to bear annually in the form of expense ratio. An expense ratio of the fund is nothing but the recurring costs that a fund house has to bear for the fund to function. These include distributor commissions, trustee fees, fund manager fees, etc. charged by the fund house for managing your fund. At the time of investment, the expense ratio might feel like just a fraction of a figure which you should not worry about, but in reality, a debt fund with a high expense ratio might impact investments in the long run.

6. Whether you want to go for growth or IDCW option

Debt fund is available for investors in two options – growth and IDCW. If you are investing in debt funds for income purpose, you may opt for the IDCW option. However, IDCW are only declared if the debt fund manages to make a profit. But if you forgo the growth option, you might benefit from compounding. That’s because, in growth option, the gains made by the debt fund are reinvested in the scheme. In the long run, this might reflect on the fund’s NAV which in turn shall benefit the fund holders.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.