Debt funds are those mutual funds that invest in different types of securities to give a decent rate of return to the investors in the form of interest. The money debt instruments are invested into fixed income securities such as government securities, debentures, treasury bills and other such money market instruments. For investors who want a stable income without taking in too much risk, debt funds are quite a good source of investment.
But there are certain things, which you should keep in mind before investing in debt funds. Let us take a look at what they are:
The expense ratio refers to the amount of fee you have to pay to the fund manager for managing your debt fund investments. Depending on the operation required for managing the fund, the expense ratio differs from one type of investment to another. The ratio may also differ with different fund houses. The returns you get from your debt instruments can be calculated by deducting the expense ratio from them. If the return on your investment is 10% and the expense ratio is 1%, then your real return would be 9%.
The effect of fluctuations of the interest rate has a direct impact on the prices of the bond. If the interest rate is soaring high, the bond prices decrease. Similarly, if the interest rate is going low, the bond price increases. So, if you keep the debt fund for a long period of time, the interest rate fluctuation observed in them will be much higher compared to a short tenure. This means with a declining rate of interest, the funds will do better in the longer run. In a similar manner, if the funds are kept for a shorter period of time, they will perform well with the increasing rate of interest.
Yield to Maturity
Another important factor you need to keep in mind about the debt fund is the yield to maturity. Yield to maturity refers to the amount of return you will get once your investments mature. If the yield to maturity rate on your investment is 7%, then this will be the sum you will be paid at the end of the term provided no changes take place in your portfolio. But this is not a reliable factor to go with. Yield to maturity can easily be manipulated by the fund manager if he follows an aggressive policy regarding portfolio management.
In a debt fund investment, a lot depends on the interest rate trend. If the interest rate is declining, then the value of bonds issued earlier increases as they have higher interest rates and would profit the investor more. Similarly, if there is an increase in the interest rate, the previously issued bonds will have a lower value for investors who would want to have bonds that pay a high amount of interest.
Surely, you would want the person or the company you are lending the money to pay back on time with due interest. This depends on the creditworthiness of the issuer of the debt fund. There are several credit rating agencies that rate these issuers on their ability to clear their dues. A company that is rated AAA by credit agencies is considered the best out there. One can easily invest in them. On the other hand, if a company is rated ‘C’, there are high chances of it defaulting in its payment. At least, this is what it appears on the paper.
These are some of the factors that you need to keep in mind while opting for a debt fund investment. It is better to have a talk with your fund manager regarding this to get a more thorough idea about the debt fund. If you’d like to know more about debt funds, check here.