Investors are unsure if mutual fund companies’ debt fund options are worth it. Debt funds don’t usually provide high returns and have only benefited those who invested for the short term and enjoyed average gains.
When choosing a debt mutual fund, investors have many choices. They find a fund that fits their goals and how much risk they are comfortable with. Important things to take into action about how the fund was invested in the past, how much it cost to invest in, the quality of the things, and how experienced the person managing the fund is.
Do not underestimate the risk of debt funds because it brags about putting your money in government bonds. Many overlook or are unaware of the potential risks associated with these funds. Now, the challenging part for investors is choosing the best debt mutual fund among the many options available. These articles highlight 6 key tips for choosing the right debt fund.
What is a Debt Fund?
Debt funds invest in securities that provide a fixed income, such as treasury bills, corporate bonds, commercial papers, and government securities, among other money market instruments. These securities have a predetermined maturity date and interest rate that the buyer earns upon maturity, which is why they are called fixed-income securities.
This fund belongs to a larger category of mutual fund schemes, which includes overnight mutual funds, liquid mutual funds, duration funds, gilt funds, credit opportunities funds, and more. A liquid fund is a specific type of debt fund.
6-Key Considerations in Choosing the Right Debt Fund
There are some parameters to consider when you are choosing a debt fund. Opting for the right debt fund will help you bring overall value to your portfolio:
● Average Maturity/Duration
Knowing the average maturity of a debt fund is important. It helps investors understand the period the fund is meant for. Matching the investment time frame with the maturity period of the fund is a smart way to avoid unnecessary risks. Before investing:
- Check the average maturity of the debt fund.
- For short-term investments, choose funds with shorter average maturity.
- If you plan to invest for a year, go for a short-term debt fund.
Understanding average maturity helps find the right balance between risk and returns in debt funds.
● Interest Rate Scenario
Understanding the market scenario for debt funds is crucial because they are affected by a change in interest rate. When the interest rate increases, the bond value in the fund decreases; when the interest value decreases, the bond value increases. This shows that if you have invested in a debt fund that holds older bonds, its value decreases when the interest rises.
Choosing funds with shorter average maturities, like short-term or ultra-short-term funds, is a good idea to avoid risks related to interest rate changes.
● Expense Ratio
The expense ratio is an important factor that should be considered in debt funds. A higher expense ratio can create a big impact on fund performance.
● Current Yield Or Portfolio Yield
The current result of a debt fund shows how much interest it earns from the bonds it holds. The overall yield will be higher if a fund invests in bonds with higher interest rates. The yield to maturity (YTM) tells us the ongoing yield of a debt fund. When comparing debt funds based on YTM, we should also consider how the extra yield is generated.
Is it because the fund is investing in lower-quality bonds? Investing money in lower-quality bonds proves risky as they may not be able to repay your invested money later. So, it’s important to look at the portfolio yield and consider the credit quality of the bonds held by the fund.
● Credit Quality Of Portfolio
It’s important to check the credit quality of the bonds and securities they invest in to choose the best debt funds. Agencies give bond ratings to show how likely they are to repay the money. The highest rating is AAA, which means it’s a safe investment. If safety is important, look for debt funds that invest in high-quality bonds (AAA or AA+ rated).
● Assets Under Management (AUM)
When picking the best debt funds, checking the total amount invested (AUM) and avoiding funds with too many corporate bonds is crucial. This is because if many investors take out their money, it can harm the fund’s performance. So, it’s safer to choose funds with substantial investments and spread your investments to reduce risks.
Conclusion
Debt mutual funds offer predictable returns and high liquidity but aren’t risk-free. Nonetheless, debt mutual funds are a popular choice for investors who prefer low-risk investments. By considering all the parameters, one can avail high returns.