Pros and Cons of Investing in Debt Mutual Funds
As interest rates on small savings and fixed deposits head downwards, investors are looking at debt funds to earn higher returns.
How does a debt mutual fund portfolio score over a single instrument?
As compared to a single instrument such as a bond, or government security or a nonconvertible debenture, debt funds help you diversify .
Any portfolio of a debt fund has 8-10 different papers, or even more, which mitigates single party risks. Debt mutual funds invest in instruments like bank CD, commercial paper, government securities, or corporate bonds.
How easy is paperwork in a mutual fund scheme?
You can get a soft copy of a mutual fund statement.Even if you lose a mutu al fund statement, it does not matter. You just need to sign on a re demption slip and sub mit it to the fund house to get your money back.
Compared to this, a bank fixed deposit re ceipt, if lost, could cre ate a lot of hurdles and paperwork.
What is the tax and liquidity advantage in a debt fund?
There is no TDS in debt mutual funds and if held for three years, one can avail indexation benefit and minimise their tax outflow. If there is a need to withdraw money ,a debt mutual fund can be broken into units of Re 1 and investors can withdraw only the required amount. In a small-saving product or a fixed deposit, you need to break the entire deposit.
What are the risks involved while investing in a debt fund?
Interest rates typically rise when the economy is growing, and fall during economic downturns. Bond prices and interest rates are inversely related. When interest rates rise, bond prices fall and vice versa. Interest rate risk is present in all debt funds but the degree could vary . Gilt funds with longer maturity carry higher interest rate while it is negligible or very low in liquid funds. A credit risk is the risk of default on a debt security that may arise from a borrower failing to make required payments. If any of the companies, whose paper the fund owns, does not pay up when it comes up for repayment, the funds’ NAV could suffer to that extent. The fund manager also has to ensure the scheme is liquid to the extent that the fund has the ability to move in and out of a scheme without impacting its value or price.