Mutual Fund Investment: Here’s a checklist for investing in debt funds

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October 19, 2021 12:51 PM

Credit rating is a signal that investors of debt securities used to ascertain the ability of an issuer to pay interest on time and repay the principal.

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Mutual funds are becoming increasingly popular. However, sometimes it gets challenging to decide on which mutual fund to choose. Debt mutual funds are one such fund.

Debt funds, in fact, are low-risk mutual funds that invest most of the money from investors into fixed income instruments such as state and central government bonds, bonds issued by banks, corporate bonds, certificates of deposit, etc. As these are low-risk mutual funds, they turn out to be one of the best options for low-risk appetite investors.

Ajinkya Kulkarni, Co-founder, Wint Wealth, says, “Since debt mutual funds are different from equity mutual funds, investors need to consider some basic yet essential steps before choosing a debt mutual fund.”

1) Credit Rating

Credit rating is a signal that investors of debt securities used to ascertain the ability of an issuer to pay interest on time and repay the principal.

“Credit rating predicts the chances of default and not the chances of recovering the money. It is like going to a restaurant perhaps; you know anything above 3-star will be good,” says Kulkarni.

Similarly, there are various ratings in bonds where AAA signifies the highest ability to repay till D, which indicates default by the issuer.

So, Kulkarni suggests picking funds that invest at least 80 per cent of the portfolio in the highest-rated bonds if you don’t want to bear credit risk.

2) Average Maturity

Average maturity is the weighted average of all the current maturities of the debt securities held in the fund.

Since, it’s always better to go for low volatility and parking money for 2-3 years, especially in a debt mutual fund, look at schemes with average maturities matching the investment horizon.

Note that, the higher the average maturity (modified duration), the more sensitive the fund returns will be to changes in interest rates.

3) Exit load

Exit load is the fee an investor needs to pay on exiting or withdrawing a mutual fund. It is charged as a percentage of the amount invested.

Let’s say a debt mutual fund you invested in with a 4 per cent yield per year has an exit load of 0.3 per cent before 60 days, and you have invested Rs 5,000, which grows to Rs 5017 in 30 days, and you want to withdraw it. You will pay Rs 15.05 as exit load charges.

Kulkarni points out, “This basically wipes out all gains. So, make a note of the exit load while picking a mutual debt fund. Don’t invest the money that is needed after 4-5 months in a fund with an exit load for withdrawals before 1 year.”

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