Tips To Follow While Investing in Debt Funds and Avoid the Traps

Updated on :  

08 min read.

Investing in today’s scenario is the most confusing and difficult thing. The traditional methods of saving are Fixed Deposits (FDs) and Recurring Deposits (RDs). FDs of commercial banks are known to be the safest options for investment. However, there is a gradual reduction of interest rates in such instruments in recent years.

Hence, people are diverting to other alternative options. There is a significant segment of investors who prefer safe and carry low-risk instruments. The investment returns dependant senior citizens choose such types of investments. They need assured returns by making a short-term investment. 

One such alternative of investment is debt funds that provide relatively higher returns than fixed deposits. The return on debt fund generally depends on the investment tenure of the fund. However, the average return on short-term debt funds is 7-9 per cent, which is higher than the return of 5-7 per cent on fixed deposits for the same term. In addition to higher returns, the debt funds also carry dividend options and are highly liquid. 

Compared to traditional funds, the debt funds are volatile. Hence, there is always some risk associated with it. An investor of a risk-averse category can mitigate such risk by diversifying his portfolio to risky and risk-free investments. 

Investors can follow the tips below for investment in debt funds to avoid any false step:

  1. An investor must avoid taking decisions based on its ranking and past performance. The data of the past performance of the debt funds do not assure the same returns in future. Hence, they must take rational decisions while investing in such assets by analysing the funds’ underlying assets.
  2. Debt instruments generally carry low risk than equities. However, debt instruments are not risk-free. Even within the wide range of debt categories, the devices have varying levels of risk.  
  3. One must not ignore the expense ratio attached to the debt funds. Consider costs before evaluating the return on investments. Most often, it is a misconception that a higher expense ratio means better management of funds. The high expense ratio may compensate for the higher revenue generated. The debt funds carrying a lower expense ratio, which the trained managers manage, can yield higher returns.
  4. The yield and price of bonds follow an inverse relationship. Hence, the bond market is highly volatile. Investors who understand the debt market have the option to invest in gilt funds. 
  5. Along with the risky nature of debt instruments, the investor must evaluate the tax implications of returns from such mutual funds. The taxability of debt instruments is different from that of debt instruments.
  6. It is essential to invest according to the set investment goals. The investor must balance his portfolio according to the requirements. The balancing of funds in liquid and non-liquid funds makes the availability of funds according to the required time horizon.

Hence, follow above tips to avoid any major the debt traps.

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