When should you invest in debt funds

Mutual funds are a popular investment vehicle for many investors. There are three main types of mutual funds – equity funds, debt funds and hybrid funds. Each category offers distinct advantages and can help to grow your wealth. When you plan to invest in mutual funds, you can invest in any of the three types to create your investment portfolio. However, before you invest you may keep in mind your investment horizon and your risk appetite.

The article lists down the reasons why it is a good time to invest in debt funds now and some tips to help you invest right. For new investors who do not know what are debt funds, they are mutual funds which invest in fixed-income securities and debt. These include government securities, debentures, commercial papers, corporate bonds and other money market instruments.

Reasons to invest in debt mutual funds right now

Advisors believe that debt fund is set to perform well in 2019. Despite the volatility due to factors such as currency depreciation, rising interest rates and rise in crude oil prices, debt mutual fund categories outperformed many equity mutual fund categories in the last year. Among the debt fund mutual categories, liquid fund category was the best performer with a return of 6.89 percent in one year. The second spot was taken up by long duration funds with a return of 6.84 percent followed by gilt funds with 6.56 percent returns and short duration funds with 6 percent in one year.

The macro uncertainties are now seeing a reverse. Oil prices have dropped almost thirty to thirty-five percent, the currency has stabilised and open market operations (OMO) have got the liquidity back to the market. This means that the government securities will remain stronger because of continuous OMOs from Reserve Bank of India. Furthermore, advisors feel that it is a wise idea to stay invested in short duration funds, the one to three year segment.

Tips before investing in debt funds

Here are some key factors you may want to consider before investing in debt funds:

  • Interest rate movements

Change in interest rate movements has a major impact on debt funds, especially long-term debt funds. While a rising rate can affect your returns negatively, a falling rate, on the other hand, can spell good news. This is mainly because of the prices of bonds and yields share an inverse relationship. As the interest rates go down, the bond prices go up and boost the net asset value (NAV) of the debt fund schemes. Conversely, when the interest rates rise, the bond prices go down and your NAV suffers.  

  • Know the credit risk

If you are a conservative investor, you may want to avoid investing in schemes that put your money in low-rated papers to generate extra income. There is a substantial risk of losing money in case the company fails to meet its repayment obligations.

  • Total expense ratio and exit loads

Fund managers charge total expense ratio to manage your portfolio when you invest in mutual funds. This is an annual fee that primarily comprises of trading fees, legal fees, auditor fees and other such operating expenses. Exit loads are charges that you may have to bear for exiting a mutual fund scheme prematurely. You may take both these expenses into consideration before taking a call on making an investment in debt mutual funds.