Even though debt funds are the biggest contributors to the mutual fund corpus in India, there is surprisingly not much literature on debt funds.
Let me start by clearing some misconceptions about debt funds:
1. Debt mutual funds are EXACTLY like bonds:
Debt funds and bonds are very different. If you can lock in today into a PSU bond at 9% current yield for a 20 year period, it is an amazing saving instrument. I daresay no fund scheme can give such a good return over such a long period. If they had zero coupon and fully back ended interest, I would have been happier, but this is a brilliant product.
2. Debt fund is only for the retired person
Not true at all. Even when you are younger, say 45 a debt fund makes sense. Invest in a longer duration fund and remove only when you retire.
3. Debt funds carry NO RISK, especially gilt funds
Debt funds carry 2 types of risk (like any debt product) – one is the risk of default (on a part of the portfolio, not the full portfolio) and interest rate risk. When interest rates go up, the value of your bond fund will go down and the reverse is also true. So depending on YOUR time horizon you should choose your funds. This means you can LOSE money EVEN in government guaranteed ‘gilt’ fund. However you can NEVER EVER lose money in a NOMINAL sense in a gilt bought and held to maturity.
4. All debt funds are the same!
Sorry, no. If you have money for the short term – say 3 days or you are accumulating money for your retirement about 30 years away you will have to choose DIFFERENT PRODUCTS. For a short duration you need to choose funds with low duration (like liquid fund) whereas for a long term requirement you will choose an Income fund or a gilt fund. Your choice will depend on a) your own outlook about the time you wish to hold the fund scheme b) how much fluctuation you can stomach c) at what point of the interest rate curve we are sitting at.
5. Indians invest very heavily in debt funds
Partially true and partially false. Indians invest in bank debts and sometimes even in post offices and LIC policies. However most of the money you see in the mutual funds are the corporate monies. These are parked in liquid funds, Fixed Maturity Plans, etc…
6. Debt funds are cheap
Not true at all. You need to be careful about debt fund costs.
7. Debt funds are useless, one should stick to bank fixed deposits, especially for older people
Wrong. Debt funds are the ONLY way you could consider deferring the tax on debt investments. If you had a bank fixed deposit you would pay tax on interest earned on a regular basis. You could convert this to a capital gain by investing in growth option.
8. It is easy to build a debt fund portfolio
Wow!! It is far more difficult to build a dynamic bond portfolio – and the Indian market does not have enough bonds on tap – so building a debt portfolio is also ALMOST a nightmare!!
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