Debt Mutual Funds for Your Folio Investment

Whenever we feel that our monthly income isn’t bringing in the financial stability we expected, we usually lean towards investment vehicles which may hold the potential to help us in building a corpus. Remember that if you are running short of money for your daily expenses at the end of every month, you are lacking effective financial planning. Financial planning is the key towards wealth creation. It teaches you how to manage your money. The first step of financial planning is understanding your monetary goals. You should be able to identify your short term and long term goals and prioritize them so that you can strategize your investments accordingly. But before you invest, you need to thoroughly evaluate your existing situation. That includes your monthly earnings, your expenditures, whether you have any liabilities, any unpaid loans, credit card bills, existing investments (if any) etc. Only when you evaluate your existing financial condition, you might be able to get a fair idea about how much money you can potentially invest to achieve your financial goals. If you are someone who falls in the category where the expenses supersede earnings, then you might have to reconsider the way you live and try to keep your expenses to minimum.

If you really want to attain financial stability in near future, you have to cut down on unnecessary expenses. It might seem tough initially, but if you look at the bigger picture, you are going to need more money when you retire then you need now. So next time you fancy visiting a restaurant, think how much you can save if cooked and ate at home. If you have already bought enough clothes in the last month, reconsider shopping in the current month. It is up to you how to manage money and save enough so that you can start investing soon. Once you have a defined set of monetary goals and learn to save some money every month, you may go ahead and try to understand your risk appetite.

If you are someone who is entirely new to financial planning, the concept of risk appetite can be a tad confusing. Risk appetite is an individual’s tolerance to allow his or her investments to bear losses and wait patiently for the scheme to start performing and giving the desired results. A conservative investor is likely to have less or zero risk tolerance. Such investors usually consider investing in traditional investment schemes that offer low interest rates. They do not mind settling with lower capital appreciations rather than risking their finances by investing in volatile markets. The dangers of investing in volatile markets is something only few can digest. These investors do not mind investing in schemes having a high risk rewards ratio. These individuals usually want to give their investment portfolio an aggressive touch and hence, do not mind taking added risk with the hope of earning better rewards. However, there is no guarantee that one may receive guaranteed capital gains by investing in risky investments. But if you are an aggressive investor who wishes to invest in equity markets but do not wish to expose your finance to the dangers of direct equities, you may consider investing your hard earned money in mutual funds. Another good thing about mutual funds is that they are available for investors of almost every risk appetite. A lot of people confuse mutual funds to be only equity oriented. This is not true at all.

So if you wish to find more about mutual funds and why one must consider adding debt funds to their investment portfolio, continue reading.

What is a mutual fund?

SEBI (Securities and Exchange Board of India) the regulatory body of mutual funds here in India, defines them as, “A mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in the offer document.

Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with the quantum of money invested by them. Investors of mutual funds are known as unitholders.

The profits or losses are shared by the investors in proportion to their investments. The mutual funds normally come out with a number of schemes with different investment objectives which are launched from time to time. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI) which regulates securities markets before it can collect funds from the public.”

To put it in simple words, mutual funds are professionally managed funds where the fund manager applies an investment strategy to meet the scheme’s investment objective by buy / selling of securities. What AMCs (Asset Management Companies) do is that they collect money from investors sharing a common investment objective and invest this pool of funds on the behalf of investors collectively across the Indian economy depending on the asset allocation of the fund. This pool of funds is referred to as a mutual fund. The money accumulated by AMCs from investors is then invested in equities and other marketable securities including corporate bonds, certificates of deposits, government securities, treasury bills, call money, etc. It is said that the performance of a mutual fund scheme depends on how its underlying assets and sectors in which they invest perform in their own streams. Mutual fund investors are allotted shares in the form of units in proportion to the money they invest and depending on the fund’s existing net asset value (NAV).

Mutual funds are further categorized by SEBI to help investors distinguish and identify schemes as per their risk appetite and investment needs. Mutual funds are usually distinguished based on certain unique attributes like asset allocation, investment objective, risk profile, etc. Some of the major mutual fund categories include equity, debt, hybrid / balanced funds, ETFs, index funds, FoFs and solution oriented.

Today we are going to focus on debt funds and help you understand why you may consider adding them to your investment portfolio:

What is a debt fund?

While equity oriented schemes invest a major portion of their assets in equity and equity related instruments, debt mutual funds predominantly invest in debt and debt related instruments. These funds invest in fixed income and money market securities like treasury bills, call money, debentures, government securities, certificates of deposits, and corporate bonds. A lot of people usually consider investing in debt funds to meet short term goals like making the down payment of their new car, renovating their home, planning a foreign vacation, etc.

How does a debt fund work?

By now you know of the fact that debt funds invest in fixed income securities like G-sec, T-bills and other debt related instruments. A debt fund later aims to sell these securities at a profitable margin. The difference between the cost price and the selling price leaves debt funds with an amount that results in either leads to the appreciation or depreciation in the Net Asset Value (NAV) of that particular fund. Debt funds are also eligible for periodical interest from the fixed income securities they invest in, and the NAV of a debt fund might depend on the interest rate offered by the fund's underlying assets.

Why should you consider adding debt funds to your mutual fund portfolio?

Every mutual fund serves its own unique purpose to the investor. For example, a tax saver fund like ELSS aims to help an investor save tax and might also help them in earning some long term capital gains. An index fund does the job of tracking its underlying index with minimal tracking error. A hybrid fund aims at balancing risk by allocating its assets to both equity and debt instruments. Similarly, debt funds have their own importance and hence, one may consider investing in these. A lot of investors usually plan debt fund investments to meet their short term goals. Also, investors who do not have a high risk appetite look at debt funds as an investment option. Debt funds like Axis Liquid Fund offer liquidity and one may consider investing in them for building an emergency fund. Because equity mutual funds are usually suited for meeting long term goals as equity related schemes tend to show results only when held for a longer time period. Also, if you have investments in an ELSS fund, this tax saving scheme comes with a three year lock in which means you cannot withdraw ELSS units in case of an emergency. Hence, a debt fund like a liquid fund might be the answer to tackle emergences.

Another plus point of having a liquid fund is that they offer diversification. When there is a market crash, a lot of investors fear losing their investments. Because debt funds invest in such diversified asset classes, you may consider adding them to your mutual fund portfolio.

You have the option of investing in debt funds via lumpsum investment or SIP. Lumpsum investment is usually opted by those who have surplus cash in their kitty which they wish to put to better use. When you make a lumpsum investment, you are allotted a large number of units as per the fund’s existing net asset value. However, if you wish to give your debt fund investments a systematic approach, you may consider investing through SIP. Systematic Investment Plan or SIP is an easy and hassle free way to continue investing without having to worry about the same every month. All one needs to do is instruct their bank and every month on a fixed date, a predetermined amount is debited from your savings account and electronically transferred to the debt fund. You may continue investing in a debt fund till your investment objective or your financial goal is achieved. SIP also paves way for rupee cost averaging. When you invest every month via SIP, you are allotted units depending on the fund’s current net asset value. If the NAV is low in a particular month, more units are allocated in proportion to the investment amount. When the NAV increases, you are allotted lesser mutual fund units. This way you benefit from rupee cost averaging.

Things to keep in mind before investing in a debt fund

Before you invest in a debt fund, make sure that your investment horizon, objective, and risk appetite align with your investments. Invest only if you feel that the scheme holds the potential to help you get near your goal. And make sure that you invest in a debt fund that is under professional management. Investing in a debt fund that is professionally managed may be more reliable than investing in a fund whose management is under constant change. So make sure that you invest in a debt fund which is owned by a reputable management. A reputed AMC usually houses experienced and credible fund manager/s.

As a responsible investor it is your duty to do some basic research about the fund before investing in it. You are entrusting your hard earned money in the hands of the AMC so it is better that you do some basic research before investing in the fund. Do some basic research like checking whether the fund has a proven track record. You may compare the fund’s performance over the past six months, one year, three years and five years. Also, do not forget to check whether the fund has been able to beat its benchmark in the past. You may also compare the funds to its peers and check for its ratings provided by rating agencies. Doing this basic research may help an investor identify whether the fund is worth investing.

Also, if you are completely new to mutual funds and investing in general, then you can always seek the help of a financial advisor or a mutual fund expert to guide you better. Alternatively, you can use the MF investment app to access expert insights and investment recommendations tailored to your needs.

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