Debt Funds often termed as bond funds are those mutual funds that invest largely in fixed-income securities like bonds, debt, T-bills, and other such money market instruments. They generate stable returns and are less volatile in comparison to equity funds. Debt funds do generate lesser returns than equity funds but there are multiple reasons why you should add debt funds to your portfolio.
Reasons to Invest in Debt Funds – Advantages
It is advisable for investors to invest in a mix of equities, debt, gold, and other instruments, according to their individual priorities, goals, and risk tolerance. Adding debt funds along with others makes the investment portfolio diverse and balanced. Below are some advantages of debt funds that give investors strong reasons to invest in them:
- Stable Returns
Debt funds are known for giving stable returns as they are less dependent on market sentiments. Debt funds invest 65% of the corpus in debt instruments like certificates of deposits, debentures, bond papers, etc. that do not fluctuate as easily as the stocks. Being less sensitive to market movements, they may not generate as high returns as equity funds but also do not fall rapidly.
- Low Risk
Conservative investors who seek capital appreciation with low risk should invest in debt funds. With investments made in fixed-income securities that have fixed maturity periods and rates of interest, they are a bit immune to market volatility. Therefore, adding these funds to the portfolio with some equity funds balances the risk-return profile. They act as a hedge against market volatility when equity funds are underperforming.
Debt funds are easy to liquidate as you can redeem them anytime and you can cash out from funds quickly. It is easier than other fixed-income investment avenues; for example, FDs, which often come with lock-in periods and penalties on premature withdrawals. Debt funds come with no such lock-in and hence, offer high liquidity.
- Good for Short-Term Goals & Emergency Funds
Debt funds are suitable to invest your surplus money and earn some interest on it. Debt funds usually offer higher interest rates than bank deposits and hence, they can be of great help to fulfill short-term goals. Also, you can keep a stash of money in debt funds to create an emergency fund to deal with incidental financial crises.
You have the flexibility to invest in debt funds through a lump sum whenever you have an additional amount of money. Alternatively, you can invest in small amounts through SIPs (Systematic Investment Plans), or transfer units from one fund to another through STPs (Systematic Transfer Plans).
- Regular Income
Debt funds have an advantage that allows investors to withdraw regular income. You can opt to get your dividend income paid as well as you can choose SWPs (Systematic Withdrawal Plans) to withdraw money by selling your units from the fund as per your needs.
- Tax Efficiency
While equity funds may be more tax-efficient than debt funds, debt funds definitely offer more tax advantages than bank deposits. When you park your money in a fixed deposit, not only do you earn lower interest on it but you also pay taxes every year. Whereas, debt funds offer higher returns and are taxed only when you redeem the units.
- Good for New Investors
As debt funds are low-risk investments, new investors can start with debt funds before they move on to market-linked equity funds. They can earn steady returns without the fear of losing money due to a market crash.
Wrapping it up:
Debt funds can diversify and stabilize your portfolio by generating steady returns from fixed-income securities. They balance against the market volatility and are suitable for low-risk appetite investors as well as first-time investors. Moreover, due to the easy redeeming process, you can use them in need of urgent liquidity and also build an emergency reserve fund.
- No, debt funds do not give guaranteed returns as they also carry interest risks, credit risks, and liquidity risks. However, they are less volatile than equity funds and are not easily fluctuated by the market trends
- Yes, debt funds can underperform in certain circumstances; for example, increasing interest rate scenario