5 Reasons Why debt funds are crucial to your long-term portfolio in 2023

You might have heard about the downfall of debt funds in India in the past few years. Ever since one incident in 2018, it has been constantly downhill for their popularity. Why are we still encouraging you to invest in debt mutual funds, then? Let us begin with an understanding of debt funds.

What are debt funds?

Mutual funds are mostly categorized based on characteristics like fund size, asset allocation, investment objectives, etc. If you have a high-risk appetite, you can invest in equity mutual funds which primarily invest in equity and related instruments. They are for investors who are okay with taking high risks for high rewards. For those who don’t want to invest in such volatile funds, there are debt mutual funds.

Debt mutual funds invest majorly in fixed-income securities like treasury bills, corporate bonds, call money, etc. They are mostly chosen by investors for corpus that cannot be risked. They provide moderate returns while keeping your hard-earned money relatively much safer as compared to equity funds.

Additional Read: Advantages of Having Debt Mutual Funds in Your Portfolio

What went wrong with debt funds?

Debt mutual funds took a slight hit after the IL&FS episode in 2018. It was the downfall of IL&FS, India’s biggest shadow banking institution, often dubbed as ‘India’s Lehman moment’. After the event, debt funds of certain categories such as credit risk funds suddenly started taking hits from downgrades and defaults with a slowing economy. They further suffered a setback due to the Coronavirus pandemic, the ensuing lockdown and recession. This chain of events has translated into risk aversion in NBFCs, structured products, realty, and the like; although only in the affected categories. In the past year, categories such as banking and PSU debt funds, corporate bond funds, and short-term funds have shown good returns, thanks to the market impact caused by the RBI’s reduction in interest rates. 

Why should you still look at debt funds in 2023?

The surprising part is that we would still suggest going for debt mutual funds in 2023. Choose debt funds with a quality underlying portfolio, preferably banking and PSU debt funds and corporate bond funds. Yes, even with the inevitable recession that has already set in. There are 5 reasons why:

1. Low risk ratio:

Debt mutual funds invest in fixed income security instruments. This makes them far less risky than a lot of other instruments. They are the sweet spot between direct equity investments and traditional instruments such as fixed deposits. If you don’t have a huge risk appetite and are seeking capital gains in the new year, you should consider corporate bond funds and banking and PSU debt funds. The money you invest will grow at a slow yet consistent pace. They can make for good lumpsum investments too.

2. Flexibility:

Yes, we are indeed talking about SIPs (Systematic Investment Plans), the best way to invest in mutual funds in terms of convenience, especially for inexperienced investors. It is a very simple process wherein you have to transfer money from your bank account to the debt fund. You can also give standing instructions to your bank for debiting a predetermined amount every month from your account. You can also modify your SIPs as per your income flow. This way, you get accountability to yourself for investing consistently while also enjoying the option to change things at any point.

3. Payout options:

There are two options for investing in debt funds- growth and dividend. What you choose depends upon your investment objectives. In the case of a growth option, your returns are reinvested in the fund. The growth option is great if you’re looking at a long-term investment. If you want returns at regular intervals, you can go for the dividend option as well. However, the growth option also comes with added long-term benefits such as an increase in the fund’s NAV (Net Asset Value) in the long term. Plus, in case of investment gains for a duration of 3 years or more, the capital gains on debt mutual funds are taxed at 20% post indexation, which is better than fixed deposits which might be taxed as per your tax slab that could go up to 30%.

4. Good for revival:

Investing in itself might seem like risky business in the year 2023, with the market showing uncertain behavior every other day. The age-old idea of diversifying becomes extremely important at this time. Make sure you don’t make the mistake of parking all your money in fixed deposits. Debt funds can make a good part of your revival strategy next year, as they are now safer with new regulations introduced this year.

5. Effect of interest rate changes:

Long term debt investments are very sensitive to changes in interest rates. When rates decrease, they are at the biggest advantage. This happens because investors pay more for instruments with higher rates in an environment of falling interests. This spike in demand pushes up the prices of bonds and NAV of plans that invest in long-term debt funds. The vice versa of this is also true.

Additional Read: What kinds of investors should opt for mutual funds?

Conclusion

The recent troubles that credit funds have had should be taken as nothing but learning by investors and the market alike. If you are well informed and aware of what you’re getting into, you can very well enjoy good returns with long-term debt mutual funds. And of course, do not forget to diversify and remember not to put all your eggs in one basket!

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