Why Invest in a Diversified Debt Mutual Fund?

The world that we live in, you need money to survive. Almost everything comes with a price tag and if you want to own it, you need to have money. We do not have to lay emphasis on the importance money has in the current times. You need money for buying basic needs like food, clothing and shelter. Then comes additional expenses like your child’s education / tuition fees, health care fees. You need money to go on a vacation, you need money to give your family the standard of living they desire, you need money to take care of your aging parents, and you need money to take care of your own needs. While there are so many ways of your money getting spent, usually you only have one type of income flow, which is mostly your monthly salary. And taking care of all the monetary needs with just a monthly pay cheque may become a tad difficult.

That is when savings come into picture. If you are someone who wishes to achieve financial stability in future, you may have to start saving at an early stage of your life. Today’s generation of youth does not realize the importance of saving. They are excited about getting a job just so that they can splurge on luxuries. Shopping and eating in fancy restaurants has become a part of their lifestyle. But they don’t realize that if their parents lived a similar lifestyle in the past, they wouldn’t have been to enjoy life the way they are doing now. Those who realize the importance of saving at an early stage in their life usually are successful with achieving their financial goals. To start saving, you may have to bring in some modifications in your lifestyle. Once you learn how to manage your expenses and start saving, the next thing to do is start investing. Yes, saving is good, but it may not be enough. That’s because keep inflation in mind, the money that you save today may not be equally valuable 10-15 years from now. Let us give you an example to help you understand this in a better way.

A one litre packaged drinking water that cost Rs. 10 two decades ago, costs Rs. 20 in the current time. That’s twice as much the two decade old selling price. So imagine the cost of other expenses like health care, house rent, etc. that one may have to bear in future. Saving alone may not be able to give you the sustainability you deserve. But to start investing, it is better to have a decent financial plan. Financial planning is essential for anyone who wishes to find success with investing. That’s because when you know your short term and long term goals, you have a clear mind set and know where and how much to invest in order to achieve those goals. It is believed that those individuals who know what they want to achieve in life are more successful in making smart investment decisions. Short and long term goals not only help you see the reality, they also help in getting a direction on how to go about with your finances.

Once you have a clear mindset and know your financial goals, the next thing for every investor to do is determine his / her appetite for risk. It is necessary for one to diversify their investment portfolio according to their risk appetite. A risk appetite is nothing but an individual’s ability to take a certain amount of risk with their finances so that they are able to achieve some capital appreciation in the long run. However, taking risk may not be favoured by everyone as there are some individuals who carry zero risk appetite. Such individuals do not wish to take any kind of risk with them and are happy with investment schemes offering fixed interest rates. However, investors should bear in mind that there is no investment that can be considered entirely risk free. There is always some kind of risk associated with every investment. Also, these fixed interest rates on offer are on the low side and may or may not help an investor achieve his / ultimate financial goal.

However, if you are someone who seeks capital appreciation and does not mind investing in market linked schemes which by the way, do not offer fixed interest, you may consider investing in mutual funds.

What is a mutual fund?

Mutual funds are becoming popular in India because of their unique risk bearing nature. Mutual funds are supposed to offer investors with an opportunity to invest in multiple markets through single investment. A mutual fund is supposed to help investors with risk management as they generally carry a diversified investment portfolio.

Here is what SEBI, the regulator of mutual funds in India, has to say about them –

“Mutual funds are 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.”

Investors are allotted mutual fund units in quantum with the investment amount and depending on the fund’s existing NAV. It is believed that the performance of a mutual fund depends on the performance of its underlying assets.

Types of mutual funds

A lot of people confuse equity funds to be the only mutual funds to be existent, but this is not true at all. SEBI has further categorized mutual funds based on their several unique attributes like risk profile, investment strategy / objective, asset allocation, etc. This categorization was made keeping in mind the interest of investors and that they should be able to take an informed investment decision.

Here are some of the major mutual fund categories:

• Equity funds: Equity funds are those mutual funds which predominantly invest in equity and equity related instruments. Since equity funds invest heavily in stocks, they are considered to carry a higher risk profile.
• Debt funds: Debt funds invest in fixed income securities like call money, corporate bonds, government securities, certificate of deposits, etc. A lot of investors consider debt funds for meeting their short term goals.
• Exchange traded funds: As per SEBI, an exchange traded fund “is an open ended scheme which replicates/tracks the particular index. Of the total assets, this fund must invest a minimum of 95 per cent in securities of a particular index (which is being replicated or tracked)”.
• Solution-oriented funds: A solution oriented fund usually aims at meeting an investor’s specific financial goals like retirement planning or building a corpus to financially secure their child’s future.
• Hybrid funds: Depending on the scheme’s nature and investment goal, a hybrid fund may invest in both equity and debt instruments.

What are debt funds? Why may one diversify their portfolio by investing in debt funds?

AMCs / fund houses collect money from investors sharing a common investment objective and invest this pool of funds across the Indian economy depending on the nature and objective of the scheme. Capital appreciation from such schemes is subject to how the market performs. Returns from mutual fund investments are never guaranteed.

However, it is always good to diversify your investment portfolio with a mix of both equity and debt. Some investors only prefer sticking to equity investments. However, there are some equity schemes that come with a predetermined lock in period. In such cases, an investor may not be able to liquidate his / her investments in case of an emergency or an emergency. Which is exactly why an investor should always have some assets allocated to debt mutual funds as well.

Debt mutual funds invest the corpus accumulated from investors sharing a common investment objective mostly in corporate bonds,treasury bills, government securities, etc. Here are some of the reasons why we feel that investors may consider investing in a diversified debt mutual fund:

• May help you with short/medium term goals: There are some investors who do not have the patience to remain invested for the long run. For such investors, or for those who specifically have short to medium term goals, a debt mutual fund investment may work in their favour. Not everyone has the ability to keep investing throughout their lifetime and want to achieve a corpus in three to five years. For such an investment horizon, a debt fund may be useful.
• Offer two investment plans: Those who are seeking investment in debt funds have two investment options – they may either opt for the direct plan or go with the growth plan. A direct plan is something that an investor can directly buy from the fund house, either by visiting manually or by visiting their website online. The expense ratio of owning a direct debt fund is generally low. However, there are some third parties who also sell mutual funds to investors. Those who buy debt mutual funds from third parties have to bear a higher expense ratio. The debt fund plan offered by a third party is referred to as a regular plan.
• Investors have two payment plans: When you are about to make the actual investment in mutual funds, you can either make a lumpsum investment, which is the traditional way of investing, or you can opt for a systematic investment plan. A systematic investment plan (SIP) is an easy and hassle free way to invest in debt mutual funds from the comfort of your home. If you are a KYC compliant individual, you can even start a SIP in debt funds by using a laptop or even your smartphone and a decent internet connection. SIP may help an investor in meeting their financial goals through systematic and regular investing. SIP allows investors to invest a fixed amount at regular intervals (usually monthly). Another good thing about SIP investments is that one does not need to have a large capital to make an investment. Investors may decide an investment amount they are comfortable with and start investing in debt funds through SIP. With SIP, all one has to do is instruct their bank following which every month on a fixed date, a predetermined amount is debited from their savings account and electronically transferred to the mutual fund. If one invests in debt funds regularly via SIP without breaking the continuation, they may even benefit from the power of compounding. Investors are allotted units every month depending on the fund’s existing NAV. When the NAV is low, investors are allotted more units. Similarly when the NAV of a debt fund is high, investors receive lesser units. This is called rupee cost averaging, something that may only be possible through SIP investment.
• Debt funds offer multiple payout options: Debts funds generally offer two payout options – growth and IDCW. If you are seeking long term investment in debt funds, you may go with the growth option. However, if you are investing in debt funds for regular income, you may opt for the IDCW options. A fund house distributes IDCW to its investors only if the scheme makes profits. Also, the intervals at which one may receive IDCW is uncertain.

There were some of the reasons why one may consider adding a diversified debt mutual fund to their investment portfolio. We hope that the above information helps you in making an informed investment decision. But if you still feel that you need further guidance, you may seek the help of a mutual fund advisor or to know more download our mutual fund app!.

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