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All about Debt funds

With the upswing in the rate of inflation and the high rate of interest, investors are finding it tough to invest in instruments that give them a good rate of return. Both equity and debt market have been quite volatile for the past few months. Debt options like fixed deposits are not giving good returns and most banks on an average offers 8%-9% returns.



So what should an investor do in such a scenario? Look for debt instruments that give a good return even if inflation is high or the market is down. Wealth managers feel debt funds can be a good option to invest as it help during times of high inflation since interest rates also go up at such times.



Debt funds helps in preserving capital and the returns you get from it are sufficient to keep up to inflation but not beat it. Investing in debt funds also offers tax advantage compared to interest bearing instruments like deposits and bonds. The frequent fluctuation in the stock markets has led to a new interest in debt funds.



A debt fund invests in fixed interest instruments like bonds, debentures, call money market and other. Since they invest in fixed income instruments and not equities they have a low level of risk. It is a way of investing in bonds indirectly. The fund would invest in a diversified portfolio of debt instruments.



One can choose appropriate debt funds so that returns are higher as interest rates go up. Normally when interest rates are high, equities take a beating. This is one more reason why debt funds are preferred in times of high interest rates.



There are several types of debt funds available in the market. But it's not as easy as picking up a fixed deposit. Some funds do well when the interest rate outlook is down and there are some funds that do better when interest rates go up. So one needs to be aware of the different types of funds and also what would be appropriate at different times so as to benefit from it. "Returns could be poor if a wrong option is chosen.



Kinds of debt funds




  • Liquid funds - which invest in very short-term instruments like call money markets

  • Short-term income funds - which invest in bonds normally with 3 months-18 months time horizons

  • Long-term income funds - 18 months to many years

  • Gilt funds - invest in government securities, which has short and long term options

  • Floating rate funds - in these funds interest rates change automatically and

  • Fixed Maturity Plans - which are close ended with fixed maturity.

Fixed maturity plans (FMP) functions much like bank fixed deposits. FMP invest in debt securities that mature at the same time as the fund. It is also not affected by interest rate fluctuations.



In an environment of high interest rates, liquid funds/liquid plus funds, floating rate funds and fixed maturity plans are preferred options.



The investment time horizon in debt funds depends on the kind of funds you are opting for. Various funds have different maturity options. For FMP, three to six months is ideal. But because of its close ended nature you have to wait for new schemes to launch. Debt funds also provide liquidity, which are not there when one directly invests in bonds.



Today, many investors prefer investing through the debt funds route instead of directly investing in the bonds as it is diversified across various companies and bonds.



If an investor is looking for safety on his/her entire investment than 100% investment should be on debt but a balanced portfolio would entail 50% in equity and 50% in debt. Investors looking for higher return more concentration should be in equities.

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