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With so many options in debt funds available in market today, it becomes very important to understand them before investing. Financial advisor Anil Rego explains the Debt funds and its varied form to help investor to choose the right scheme among many floating in the market.
Most of us consider debt mutual funds to be the poorer brethren of the equity mutual funds which garner most of the attention. A debt mutual fund scheme invests in debt papers like Government bonds, fixed deposits, approved private deposits and so on. By investing in debt instruments, these funds ensure low risk and provide stable income to the investors. It is important to hold the right mix of Debt ' Equity in the portfolio that will help you optimize returns while managing returns.
As a first step, we need to understand the basic difference between bonds and debt mutual funds because often they are erroneously perceived to be the same.
The classification incase of debt mutual funds is typically based on the underlying instruments, the most commonly used mutual funds within this category are '
Liquid Funds / Liquid Plus Funds or Money Market Funds
'Liquid', here means anything that is almost as good as cash. Money market funds or Liquid funds as they are commonly known, are one of the safest places to park your money for short periods of time. The funds invest into money market securities and debt securities that mature in 91 days.
Floating rate funds or Floaters invest into floating rate debt securities. Most of the debt securities in a floater fund will mature within a year. The main benefit of investing into a floater fund is that when the RBI increases the interest rates, the interest rates on floating rate debt securities also increase, thus when interest rates are expected to rise, floaters are better debt investments than other debt funds.
Floating rate funds invest 65% to 100% of their money into floating rate instruments and the rest in other debt securities.
They invest their corpus in securities issued by the government. These funds carry zero default risk but are associated with interest rate risk. So, there could be a possibility that the debt funds lose some part of their net asset value (NAV) also. But these schemes are safer as they invest in papers backed by the government.
A type of mutual fund which emphasizes on current income, either on a monthly or quarterly basis, as opposed to capital appreciation. Such funds hold a variety of government, municipal and corporate debt obligations, preferred stock, money market instruments, and dividend-paying stocks. These have a tendency of moving in the opposite direction as compared to Interest rates. Hence it would be a good option to avail when the interest rates have peaked and are likely to turnaround.
Fixed Maturity Plans
FMP is a closed-ended fund that invests in debt and money market instruments of the same maturity as the stated maturity of the plan. The focus of a fixed maturity plan is to provide a stream of income through interest payments, while exposing the investor to a lower level of risk.
Monthly Income Plans (MIP)
They invest most of their corpus in debt instruments and a minimum in equities. They get the benefits of both equity and debt market. These schemes rank slightly high on the risk-return matrix. These try to give you a monthly income in the form of dividends, which is of course not guaranteed. These funds are for investors, who have a big corpus initially, and would like to generate a monthly income for themselves with low to moderate risk.
And finally, here is a quick reckoner on debt mutual funds -
Hope this helps you in choosing the right debt mutual fund to complement and balance your portfolio.
The author is CEO & Founder of Right Horizons. He can be reached at firstname.lastname@example.org
READ MORE ON Liquid Funds / Liquid Plus Funds or Money Market Funds, Floating Rate Funds, Gilt Funds, Income Funds, Fixed Maturity Plans, Monthly Income Plans
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