Mutual fund investors, especially who have invested in debt mutual funds often mistake them to be secure and protected from market risks. But like all other mutual funds, debt funds are also prone to market risks. Recent sharp falls in the values of debt mutual funds of some big AMCs, left investors in shock. Below given are a few points, which one should keep in mind before putting money in debt mutual funds:
All debt mutual funds are different
Debt mutual funds are much more than traditional bank deposit. It is bit complex, as it comes with a range of schemes, each dedicated to different purposes. Short term investment schemes benefit from interest rate fall, while long term investment locks-in money at a particular rate.
Never run after an investment, just because its offering great returns. Always choose a fund that matches your needs and expectations, for example, the duration of investment, or liquidity.
Check the rate flow
Interest rates environment play a big role in growth of debt mutual funds. Where rising rate negatively impacts most debt funds, fall in rate brings good news to the investors. This is due to the inverse relationship amid prices of bonds and yields. When interest rates take a dip, the bond prices swell and it boost NAVs of the debt mutual fund schemes.
If you are a conservative investor, you should avoid investing in schemes that invest in lower-rated papers to generate extra income. Do some research on your own or seek help from financial advisor, to check the credit risk associated with the fund. Some schemes may bet on lower-rated papers to generate better returns, but it comes with the risk of losing money.
Debt fund is treated as a capital asset. The gains are taxed as per your tax bracket if you sell in less than 3 years of buying. The gains are taxed at 20% after cost indexation, if sold after 3 years. Just this one factor, gives it a significant edge over Fixed Deposits.