Investors, especially those who are novices in the investment arena, can get foxed and confused about different kinds of investment like mutual funds, debt funds, equity and the like. To make matters worse, there are several myths that surround different types of investment and these trickle through the grapevine of the investment world and confuse people even more. Believing a myth, say, about debt funds, can often land investors in a soup and prevent them from making what might have been sound investment decisions. Therefore, before you invest in debt mutual funds, you should be aware about certain myths and the realities of such instruments.
Debt Funds – Explained Briefly
Often, you will discover that investors (and if you are an investor yourself) have a wealth of information at their feet. In the huge amount of information that is around, investors can easily get lost and end up with little or no knowledge about certain financial instruments, like debt funds, for example. As an investor, the main thing to remember is that each investor is different, and has unique financial goals. The other thing to be aware of is that all investments have pros and cons, and investors need to weigh these before making decisions, based on their own knowledge and aspirations. Before you go ahead and understand about myths in debt mutual funds, you should know what a debt fund is.
Essentially, debt funds are mutual funds. These invest in securities of a fixed income nature. Securities that are invested in may be treasury bills and bonds. Debt funds entail many funds that invest for the short term, mid-term and longer term. With any debt fund, investors can select monthly income plans, liquid funds, short-run plans, and plans that have fixed payouts at maturity.
Perceptions and Myths About Debt Funds
The primary aim of investing in a debt fund is to preserve capital and to generate an income in a steady stream. Investors who do not wish to slip and slide, and suddenly rise with the volatility of equity prefer debt mutual funds as investment avenues. Therefore, debt mutual funds are clearly for investors with a low-risk tolerance. However, the returns that investors may get from debt mutual funds may be low in comparison with investments in equity. Here are some key myths about debt funds that should be debunked:
- There is No Risk with a Debt Mutual Fund
Common knowledge should tell investors that any kind of investment, whether it is debt or equity, can never exist completely without risk. Nonetheless, the nature of the risk can vary. In the case of debt mutual funds, the related risk lies in the credit and rates of interest. The value of any bond (in terms of its price) is inversely proportional to interest rates that prevail at any given time. If interest rates go up, the value or price of the bond decreases, and vice-versa. If the maturity profile of any portfolio is quite high, it is naturally exposed to more risks as far as interest rates are concerned.
Besides interest rates affecting debt funds, the profile of any company has a direct influence on its creditworthiness. This is where credit risk comes into play. If the issuer of bonds is known to make timely interest payouts and has the capability to pay the interest at maturity, the credit risk of the bond is decreased.
- Only Big Investments Can be Made with Debt Funds
The other myth that revolves around debt funds is that huge investments must be made in them, and hence, only meant for corporate investment and institutions. This is not true, as debt funds have the ability to offer investors a balance and diversification in their financial portfolio. Consequently, they provide investors with stability.
Why the myth about debt funds requiring huge amounts of investment goes around, is because the premise only holds true if investors purchase financial instruments from secondary markets directly. Debt funds are good for small investors who wish to make a foray into investment with as little as Rs. 1,000 via the route of mutual funds.
- You Get Only Positive Returns from Debt Funds
In the investor community, there is a general belief that liquid funds can never generate “negative returns”. With regard to liquid funds, risks that relate to interest rates cannot be relevant as instruments in such portfolios hold tenors of maturity up to 91 days. The fund managers of debt mutual funds opt to choose high credit ratings to maintain a good standing in portfolios, making them less prone to risks. Nonetheless, it is a known fact that liquid funds cannot be above risks that the markets pose.
The Homework Must Be Done
Whether you choose debt funds or equity to invest in, or for that matter, any other investment instrument, you, the investor, must do some due diligence before you tread into the investment scene. The road to good decisions is to evaluate your goals and then choose your investments wisely with logic.
