Looking at the current economic landscape, you can see why now is a good time to invest in debt funds. Potentially, interest rates are stabilising, the risk-return balance is improving, and bond prices seem favourable.
Unlike Equity Funds, Debt Funds are considered low risk and are ideal for conservative investors seeking stable returns. They offer liquidity, ease of investment and diversification across various debt instruments. However, Debt Funds are subject to interest rates and credit risk.
Bond prices and interest rates have an inverse relationship; when interest rates fall, bond prices go up. This results in appreciation of the bond value that the debt funds hold which, in turn, leads to higher returns.
The best time to begin your SIP is right now. No matter your age, the power of compounding works wonders over the long term. The earlier you start, the more time your investments have to grow rapidly. Even small, regular contributions can accumulate into substantial wealth over time.
When to exit? "No one can time the market consistently over the long term. You should exit your investments only if you need the money or if your fund has been underperforming. If your fund is underperforming, you should assess whether the entire category has been struggling or it is just your fund.
Since interest rates movement are inversely proportional to the bond prices a higher long tenure bond yield means less funds would be deployed in lower tenure bonds and current rates fall. Investors start to expect that interest rate will fall more in future which further leads to an increase in current rates.
There won't be much impact on debt funds if the equity market crashes because the dynamics of the fixed-income market are very different. What has a bearing on debt funds is the general state of the economy and inflation rates. If inflation goes up, interest rates go up. Bonds are hit if interest rates go up.
Some of the major risks in these instruments/funds are: 1) Interest risk- This is also known as price risk. Whenever there is a change is the interest rates the price of a debt instrument also changes.
This can happen for a number of reasons, including market downturns, concentration risk, regulatory changes, unforeseen events, volatility, lack of knowledge, and unreliable fund managers. Mutual funds offer many benefits to investors.
Yes, most debt funds allow withdrawals anytime without incurring an exit penalty. Additionally, you can set up a Systematic Withdrawal Plan (SWP) to automate monthly withdrawals from your funds.
While there are broadly two risks surrounding debt funds, namely credit risk and interest rate risk, recent credit events have highlighted another investment risk within debt funds, viz. liquidity risk. Each of these risks is discussed below, along with how the fund managers mitigate such risks.
Currently 2 – 3 year FD interest rates for major public and private sector banks range from 5.1 – 5.4%. Unlike FDs, debt funds do not give assured returns. Returns of debt funds are market linked.
Debt funds usually diversify across various securities to ensure stable returns. While there are no guarantees, the returns are usually in an expected range. Hence, low-risk investors find them ideal. These funds are also suitable for short-term investors and medium-term investors.
“However, if we're talking about high-interest credit card debt — 20% or more — selling assets to pay it off makes sense. You can't out-earn such high rates; carrying that debt will erode your wealth over time,” he said.
If an investor is looking for reliable income, now can be a good time to consider investment-grade bonds. If an investor is looking to diversify their portfolio, they should consider a medium-term investment-grade bond fund which could benefit if and when the Fed pivots from raising interest rates.
Overnight Funds
These overnight instruments are backed by collateral which comprises of Government Securities, and so these funds also have no credit risk. These are the safest debt funds but their yield is usually also the lowest. Overnight funds are suitable for parking your funds for a few days.
Liquidity: Debt funds feature high liquidity, with speedy redemption, usually within one or two working days. Unlike fixed deposits, there's no lock-in period, but some funds may impose minor exit costs for early withdrawal.
Which is better debt fund or equity fund? The choice between debt and equity funds depends on individual investment goals, risk tolerance, and time horizon. Equity funds offer higher potential returns but come with higher risk, while debt funds are safer but offer lower returns.
Do you lose all the money if the stock market crashes? No, a stock market crash only indicates a fall in prices where a majority of investors face losses but do not completely lose all the money. The money is lost only when the positions are sold during or after the crash.
When interest rates rise, debt mutual funds investing in shorter-term bonds are generally more resilient. These funds are less affected by interest rate fluctuations and can provide stable returns. For short-term investments, liquid funds or low-duration funds are suitable.
Most professional traders move to cash or cash equivalents when there is real turbulence in the markets. Keep at least a small portion of your portfolio in guaranteed investments that won't fall with the markets.
Hence, ideally, the best time to invest in debt funds would be when the interest rates are falling or are expected to fall in the recent future. As the interest rates go down, the price of bonds increases, which can make the debt fund's Net Asset Value (NAV ) rise.
It's not too late to join the bond party. If you're still parked in cash or cash equivalents in lieu of bonds—the “T-bill and chill” strategy made popular in 2022—you're losing out on the daily income accrual provided by higher-yielding bonds, as well as the potential price gains as yields continue to decline.