Governments prefer bonds that are referred to as bonds, debt, and fixed income instruments, but they all sound similar. With the exception of equity, a form of shares in a corporation, debt establishes a lender-borrower relationship between two parties. The borrower raises funds by selling bonds, while the investor seeks a guaranteed fixed income by purchasing such bonds.
Here is the guide for first-time investors entering debt funds. Read till the end.
What are the benefits associated with debt funds?
Fixed income investments offer a variety of benefits to investors, depending on their financial objectives. These are as follows:
- To begin with, debt funds provide protection against stock market risk. They are less risky than stocks. These debt fund investments will help to offset some of the equity losses if stocks fall out of favour.
- Debt funds are the best option for preserving capital. Capital preservation refers to safeguarding your investment’s absolute value through assets that have a stated return on principal goal.
- It provides a pivotal source of consistent income. Fixed income funds can assist you in generating a consistent stream of income. In the form of regular dividends on bond funds, investors earn income at periodic intervals.
- Debt mutual funds provide return enhancement with a higher level of risk, boosting total returns.
Are there any risks associated with debt funds?
- The interest rate risk is a major consideration. There is an opposite relation between the both. Bond prices fall when interest rates rise and vice versa. Bond market price volatility is primarily caused by interest rate changes.
- Inflation is the second important risk. Bonds pay out a set amount of money at regular intervals. For instance, if the rate of inflation outpaces the fixed amount of income, the investor’s purchasing power is eroded.
- One will take credit risk and interest rate risk when investing in corporate bonds. If credit risk occurs, the investor’s principal may not be fully recovered. For smaller businesses, this is a major consideration.
How to opt for the right and most convenient debt fund?
There are major things that you must consider here. These are as follows:
- Check whether your risk tolerance is going with the fund’s credit profile or not. Stick to a gilt fund in case you want a zero-risk fund because they don’t have any credit risk.
- Examine your time frame. It is an important consideration. If you need to return in a year, don’t put your money in a long-term debt fund with instruments with a maturity of more than five years. You have the option of investing in a short-term debt fund or a liquid or ultra-short-term fund.
- Even though interest rates are the most significant factor in determining debt fund returns, you should choose a debt fund based on your assessment of where they are supposed to head.
Hence, make a note of the above-discussed things at the time of entering into the debt funds market. Cross-check every detail in order to avoid all the mistakes.