What are the risks of investing in Debt Funds? Find out

By: |
July 23, 2021 6:59 PM

Investors could also opt for debt funds as they offer flexibility to switch between funds, liquidity and decent returns. However, be aware of the associated risks before investing in debt funds.

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Debt Mutual Funds usually invest in a mix of debt or fixed-income securities. These include government securities, money market instruments, corporate bonds of varying time horizons, commercial paper, etc.

Debt funds come with a fixed interest-earning potential with a predetermined maturity period. These funds are inherently low-risk investment avenues compared to high-risk equity funds, which are subject to market volatility.

However, note that even debt funds are not entirely risk-free. Debt funds are also prone to credit risk and interest rate risk, unlike bank FDs.

Hence, experts say, it is important to understand and evaluate certain risks associated with debt funds before investing in them.

Things to consider before investing in debt funds;

Risk of Interest rate – The interest rate fluctuation has a big impact on the valuation of debt Mutual Funds. Experts say, since debt mutual funds invest primarily in bond instruments, a falling interest rate translates into better earnings.

For instance, a fund manager generally opts for long term securities to lock the gains for a longer tenure when the interest rates are moving in a downward direction.

Credit risk- If a fund manager invests in debt securities with a low credit rating, default is probable. Hence, fund managers usually invest in instruments with a high credit score. Additionally, high rated instruments are also prone to fewer fluctuations, significantly reducing the credit risk.

Market risk – Certain debt mutual funds such as dynamic bond schemes are subject to specific risks, for instance, portfolio managers frequently change the investment mix and tenure based on the interest rate movements. Hence, if the fund manager’s estimates go wrong, the investments can go in a loss.

Along with the risks, depending on the market conditions and investment period, the returns on debt funds include interest income and capital appreciation in the security value, be it for the short or medium term.

Note that similar to equity funds, the returns from debt mutual funds are not guaranteed and depend upon the NAV of the fund.

Industry experts say, investors can meet diverse financial goals with investments in debt funds. It can be as an alternate income source, retirement planning tool, an investment option for moderate to low-risk appetite investors, who want to earn higher returns over fixed deposits rates.

Experts say investors could also opt for debt funds as they offer flexibility to switch between funds, liquidity and decent returns. However, be aware of the associated risks before investing in debt funds.

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