Here Are All the Reasons Why You Should Never Neglect Debt Mutual Funds

If you look at the historical records to have a bird’s eye view on the overall performance of all asset classes over the years, you will see that debt mutual funds have performed better than equity funds over many a time spans. No doubt, equities are the most profitable investment avenue over the long-term horizon, but when it comes to short and medium terms, there is nothing that can beat the popularity and effectiveness of debt funds. Debt does not just fulfill investment needs across investment tenures but also different interest rate scenarios and risk tolerances. Gone are the days, when debt funds were looked at only from the tax benefit perspective. Today, debt funds are far more popular and for many different reasons. Here is why you should never underestimate the potential of debt funds -

The returns offered by debt funds are significantly good -

If you compare risk free investment options such as bank fixed deposits and small savings schemes with debt funds, you will notice that debt funds offer considerably high returns. Just look at the interest your savings bank account is offering you. If you go on to compare it with money market mutual funds such as ultra short-term debt funds and liquid funds, you will realise that you are keeping a lot of money idle in your bank account without letting it earn for you. Money market mutual funds are not just high yielding but also have no exit load.

Debt funds offer higher returns than risk free investment avenues -

Money market securities such as CDs/CP and bonds offer higher returns than risk free investment options. Besides offering high yields, their prices rise with a dip in interest rates or improvement in credit rating. In case the conditions are reversed, the prices might dip. So, basically debt funds are subject to market risks.

But there is a relationship called risk-return relationship in this field, which applies in this case. Because of this relationship, the return amount obtained from debt funds is large when the risks are higher.

You will be happy to know that the risk associated with debt funds is lower than the risk associated with large cap and mid cap equity funds.

Having different categories of debt funds in your portfolio in the right proportions -

The risk/ return features displayed by different debt funds are different. The change in the interest rates is a considerable factor here. While long term debt funds are highly sensitive to changes in the rate of interest, short term debt funds are not that sensitive. Corporate bond funds or credit opportunities funds will be able to offer a slightly higher yield (maybe a few extra percentage points) to an investor, if he chooses to invest in papers that are slightly lower rated.

A lot of financial experts are of the opinion that one should have a mixed portfolio. That means you should have more than one single variety of debt funds in your portfolio. For the best mix, 50% of your portfolio should comprise long term debt funds. These may include long term gilt funds, dynamic bond funds, income funds etc. The remaining 50% can be short term debt funds such as short term gilt funds and credit opportunities funds.

You can also go for another profitable mix- 60% long term and 40% short term debt funds. You can adjust these percentages according to your return expectations and financial goals or other requirements. Debt management in your portfolio is of the utmost importance, if you want good returns.

Here are the final words -

From the above discussion, it may be inferred that debt funds are such a kind of funds that can offer great returns even during phases of capital market and global economic uncertainties. A lot of economists are of the opinion that demonetization could better the situation of liquidity in the banking system, which could reduce the interest rates in the times to come. But there are risks associated with the crude price trajectory and US interest rates, that could come in the way.

Nevertheless, now we know that the risk/return sensitivity of various categories of debt funds to interest rates is different. And this is the reason why solutions to different interest rate challenges may be found in debt funds.