Wary of the stock markets and want to invest for medium to long term?
Your search ends with debt funds!

It is a fact that the risk appetites of investors are as varied as their colour choices. There is nothing wrong with it. But when it is repeatedly said that if you are investing for long-term, only equity mutual funds are the right choice; then, the investors with a lower risk appetite may feel a bit left out. Equity funds may be a good choice for your long-term goals, but there are also some debt funds types that could fit the bill if the risk associated with the former is not your cup of tea.

If you know what debt funds are, then let us go a step further and tell you how is it that they generate returns. The choice of the best debt funds for investment also, just like any other mutual fund, depends upon your investment objective and risk appetite. The returns gathered by debt mutual funds come from two sources- the interest accrued by the underlying securities and the capital gains garnered.

Now, though it is widely said that debt mutual funds come with very low risk, it is practically not true for all the funds. The two major types of risks associated with investing in debt funds are interest rate risk and credit risk. The former is related to the fluctuation in the bond price, with fluctuation in the interest rates of the market. The longer the duration of a debt fund, the more it is exposed to interest rate risk. The other risk is credit risk, which is basically saying that the party you are lending your money to through the debt security, may not be able to repay the money back to you.

The interest rates are inversely proportional to the bond’s price. If the interest rate falls, the bond price increases. Let us understand this with an example. If you purchase a bond of face value Rs 1000 at 8% interest and maturity of 5 years, the interest on your bond will be 8% of Rs 1000, i.e. Rs 80 per year. Now, when the market interest rate increases, the new bonds will be more lucrative than yours, and hence, your bond will trade at a lower price than the original face value. Similarly, the bond price goes up in the case of a decrease in interest rate. Now, by varying the duration of the securities held in a debt fund, the fund managers may aim to gain an advantage from the interest rate changes. Now, different debt funds types adopt different investment strategies to achieve their objectives, and thus, these risks come in different degrees with every type of fund. Let us see how.

If you want to invest for a medium to long term goal, then you can match your investment horizon with the modified duration of the debt fund given in the fund’s fact sheet. Typically, a medium to long-duration debt fund or a long duration debt fund can work for medium to long term goals because they invest in securities such that Macaulay duration of the portfolio is 4-7 years and more than 7 years respectively. You can read more about the Macaulay duration

Here are some of your probable goals and the probable debt fund types that can be invested in to achieve the goals-



You can read more about these types of debt funds and how they work

1. The longer-duration debt funds tend to get more exposed to the interest rate fluctuations thereby causing volatility in the bond prices and thus in the NAVs of the funds.

2. Keep an eye out for the credit ratings of the kind of papers your chosen fund invests in. At times, lower-rated securities are invested in, in order to increase the yield; but such securities can be less liquid in nature and carry greater credit risk.

3. Just like investing all your corpus in only equity-related funds can make your portfolio lopsided, investing in debt funds alone can do the same. What you can aim for is a balanced portfolio with a mix of equity and debt securities.

Want to know about how to invest in debt funds? Begin