In a world obsessed with equity funds, there are debt funds that offer liquidity, stability and price protection. What you can also expect from debt funds is the possibility of regular income on your investments. But the choice of debt funds is not simple because you have a wide array of products across credit classes and across maturities. The first question is whether is it good to invest in debt mutual fund and how to invest in debt funds online. Remember that debt mutual funds give you stability and regular income. Here are 8 points that you must consider before investing in these debt funds.
8 points to remember when investing in debt funds
1. Be very clear on why you are investing in debt funds. You are not in debt funds for aggression and high risk. That is something you can get in equity funds anyway. You are in debt funds to partially diversify your risk in equity funds and partially to give stability to your portfolio. That should be your underlying thought process while investing in debt funds, in the first place.
2. Make your choice based on your specific requirements. For example, if you are having a fund requirement after 2 years then a liquid fund or a liquid plus fund will work best. On the other hand if you have a fund requirement in 5 years then a bond fund can work more productively. Be specifically careful about credit opportunities funds because they may give higher returns but it comes at a steeply higher cost.
3. The third point is a logical corollary to the previous point. What should be your total exposure to debt? That largely depends on your financial plan so that is where you got to start. When you have long term goals like retirement or your child’s future, then you can adopt an equity approach. But for goals in the next 2-5 years, debt funds will work better. Work out your debt component accordingly and also based on your risk capacity.
4. Debt funds offer you a lot of flexibility. You can structure a debt fund as a growth plan or as a dividend plan but either ways you can be assured of regular income. Different methods of taking returns out a debt mutual fund have different tax implications. For example, if you want to be more tax efficient, then you can opt for a systematic withdrawal plan of a debt fund rather than a dividend plan.
5. The lower volatility of debt funds makes them ideal instruments to reduce overall risk of your portfolio. Returns are one side to your financial plan. The other side is risk. If you want your returns and your liquidity to work your way, then you need to manage risk effectively. That is what debt funds can help you do. That is where debt funds debt funds fit into y our overall portfolio.
6. How do you plan your milestones? You are due to retire after 2 years and are fully invested in equity funds. What should you do? You need to shift to debt or liquid funds in a phased manner. Debt funds and liquid funds are very useful when you want to plan for your milestones along the path to your goals. As you get too close to your goals, you cannot afford to take a liquidity risk and debt funds would be a better choice.
7. Debt funds are an interesting play on interest and inflation. For example, when you are invested in a bank FD, what happens if the rates go down in the market? Your subsequent reinvestments will happen at lower rates. In case of debt funds, lower rates will reduce bond yields and increase the bond prices. This benefits the bond funds, especially funds that have a longer duration in their debt portfolio.
8. Finally, tax perspective is critical in debt funds. Compared to equity funds, debt funds may get a less favourable treatment in terms of dividend distribution tax (DDT). However, with LTCG on equity funds being taxed at 10% without indexation benefit, debt funds have an additional advantage since they also get the benefit of indexation. We all know that debt funds are already more efficient than FDs and corporate deposits in terms of tax treatment. What is more important is that you can actually structure your debt fund payouts in the form of a SWP, which is a lot more tax efficient as it only taxes the returns and not the principal payouts.
Debt funds add value to your portfolio in terms of stability, security and certainty. Above all, they provide the much needed diversification from an equity concentrated portfolio.