5 Mantras for Debt Mutual Funds

5 Mantras for Debt Mutual Funds

1. Fixed Income Securities: Debt mutual funds, managed by professional managers, invest in a range of fixed-income or interest-bearing securities. When you invest in a debt mutual fund, you are essentially lending to the issuer via the mutual fund. In exchange, the issuer pays the mutual fund some interest which leads to an appreciation in the value of your investment. While debt funds are stable and low-risk instruments, it is important to note that they are not risk-free.

2. Credit Rating is important: Institutions such as CRISIL and ICRA rate debt instruments based on their ability to pay their financial obligation. Higher credit rated instruments are safer and thus, offer a lower rate of return. Similarly, lower credit rated instruments are riskier but offer a higher rate of return to compensate for higher risk.

3. Types of Debt Funds: There are several types of debt funds, which could be segregated as per the type of borrower (company or government), maturity of the securities in the fund (overnight, 91-day, short-term, medium-term, etc), duration of the fixed-income securities, and as per credit rating (AAA, AA, etc.).

4. Benefits: Debt funds are highly liquid and relatively safer than equities. Historically, they have also provided better returns than FDs. They complement equities and can help you build a balanced portfolio where the equity component can help you grow your money while the debt component can help you protect your money.

5. Risks: Just as there is ‘no free lunch’ there is no ‘risk-free’ investment. Debt mutual funds have two primary risks. First is interest rate risk, i.e., the impact of changing interest rates on the value of the fixed-income security and the second is credit risk, i.e., risk that the issuer will default on paying the interest rate and/or principal.