The right debt fund will never be wrong for you

Nitin VyakaranamArthaYantra.comMany of us live in a myth that long term investments mean relying on equity markets and completely ignoring the debts as a part of investment strategy. Owing to lack of awareness about debt funds, a layman hesitates to invest in it. But here is what a debt fund is and its types to help everyone understand its criticality.Debt funds are a type of mutual funds invested in different debt based instruments like government bonds, corporate bonds and money market instruments. The gains in these debt funds are derived from the interest payments as well as capital gains due to interest rate fluctuations. The fund allocation for debt instrument is always based on investment objective/s of the investor. For example, for an investment objective of low risk and higher liquidity, money market instruments are used for the funds as these instruments are not much affected by the interest rate fluctuations.Below are some varieties of debt funds which are categorized as per their investment objectives – 1)Money Market/Ultra Short Term Fund – This type of funds focuses on providing high liquidity to investments and is lower in risk. The instruments invested in are money market instruments like treasury bills issued by RBI. The average maturity of the instruments is less than 1 year which shows that it is not much impacted by interest rate fluctuations. Suitable for – Investors having surplus cash and want to invest in safe instruments giving returns at par with inflation rates. This is also suitable for investments where the liquidity is the primary objective.2)Short Term Debt Funds – These debt funds include investments in bonds with average maturity level of less than 3 years. In terms of liquidity, they are not as liquid as money markets but still more liquid as compared to other debt funds.Suitable for – Investment objective of returns within 1 year to 2 years . Can be mixed with other debt instruments to provide stability to the investments against interest rate fluctuations.3)Income Funds – These funds possess a higher risk and are more suitable for long term investments. These investments are in a combination of government bonds and money market instruments. These funds also have exit restrictions as premature withdrawals within 1 year can attract penalties.Suitable For –As the fund is affected by interest rate changes and does have exit penalties, it suits investors with medium to long term investment horizon.4)Gilt Funds – Gilt funds invest only in government securities. Some of them are focused on long term government bonds. These funds carry almost no credit risk. However, they may not be safe bet, given their high sensitivity to changes in interest rates. If the interest rates go down, the bond prices go up and these schemes report very good capital appreciation. However, when the interest rates rise in a short span, these schemes can report losses.Suitable for – For investors who have a view on interest rates. If an investor expects the interest rates to go down, he can invest in such schemes. However, one must keep a track of interest rates movements to ensure timely entry into and exit from these schemes. Also one should be prepared to stomach interim volatility.5)Fixed Maturity Plans – These are close ended debt mutual funds which have predefined investment tenure. Unlike other open ended funds, here, the investments are held till maturity and are focused on pools not sensitive to interest rate changes. These funds are treated as an alternative to fixed deposits in banks as the taxability in these funds are lower. Suitable for – For investors averse to risk, who do not want to involve in investments sensitive to interest rate fluctuation and aim for short to medium term investments.Debt funds selection is a very critical exercise. A right selection is responsible for not only rendering stability to the investments but also for providing suitable returns.