5 types of debt funds you can invest in
Debt funds are not only
tax-efficient but can also offer higher returns to investors. Sanket Dhanorkar
lists five different types of debt funds in which you can invest, based on your
goals and investment tenure.
1 Gilt funds
These funds invest in
all types of government debt, including bonds issued by the central bank on
behalf of the Centre as well as those issued by the state governments. Since
gilt funds invest in papers backed by the governments, they carry zero default
risk. However, that does not mean they are safe from all aspects: Interest rate
risks could be a concern. In fact, long-term gilt funds are the riskiest among
debt funds, as they are most sensitive to interest rate changes.
WHO SHOULD INVEST Only those who are comfortable with a high degree of risk and looking for capital appreciation instead of protection should invest in a gilt fund.
Underlying bond prices will fluctuate wildly and will reflect in the fund's NAV.
TIME HORIZON Investors should ideally put money in a long-term gilt fund during a declining interest rate scenario with a time horizon of at least 18-24 months. You should invest in a short-term gilt fund for about one year.
WHO SHOULD INVEST Only those who are comfortable with a high degree of risk and looking for capital appreciation instead of protection should invest in a gilt fund.
Underlying bond prices will fluctuate wildly and will reflect in the fund's NAV.
TIME HORIZON Investors should ideally put money in a long-term gilt fund during a declining interest rate scenario with a time horizon of at least 18-24 months. You should invest in a short-term gilt fund for about one year.
2 Short-term funds
They invest in
debt securities, such as commercial papers (CP), Certificate Of Deposits (CD)
and bonds with a maturity of 3-6 months. They are not affected by changes in
interest rates, so the returns profile is mostly consistent. But they tend to
give slightly higher returns in comparison to liquid funds as they invest in
slightly longer tenure papers.
WHO SHOULD INVEST Investors looking
to park surplus money, but want to earn higher return than a liquid fund can
invest in a short-term debt fund TIME HORIZON Short-term funds are best suited
for an investment horizon of 6-12 months.
3 Income funds
These funds invest
corpus across debt instruments, such as bonds, corporate debentures and government
securities. They can also invest across a range of maturity profiles, i.e. they
have the flexibility to invest in short-term instruments of upto 1-2 years as
well as in long tenure papers of upto 15-20 years. These funds typically take
aggressive calls based on the interest rate outlook to take advantage of the
rate movements.
WHO SHOULD INVEST This type of fund works well for long-term investors, who have a high risk appetite since there is high interest rate risk associated with it. Invest in an income fund if you want to gain from both rising and falling interest rate scenarios.
TIME HORIZON Although income funds give the best returns in a falling interest rate scenario, one can invest across the entire rate cycle to earn good returns from them.
WHO SHOULD INVEST This type of fund works well for long-term investors, who have a high risk appetite since there is high interest rate risk associated with it. Invest in an income fund if you want to gain from both rising and falling interest rate scenarios.
TIME HORIZON Although income funds give the best returns in a falling interest rate scenario, one can invest across the entire rate cycle to earn good returns from them.
4 Fixed maturity plans
FMPs have a
fixed tenure. They invest in papers with matching maturity. They are typically
held till maturity and, therefore, takes away the interest rate risk. Even if
interest rates move up, the fund NAV is not affected. FMPs offer returns that
are relatively predictable, though not guaranteed. However, there is some
reinvestment risk involved if interest rates prevailing at maturity are lower.
WHO SHOULD INVEST FMP is the answer for those looking to park their money for a fixed tenure during uncertain interest rate movements.
TIME HORIZON Opt for long-term FMPs, say, for 3-5 years, if you are looking at high yields. You may use shorter tenure FMPs in the 3-6 month horizon if you want to take advantage of a sharp spike in short-term rates.
WHO SHOULD INVEST FMP is the answer for those looking to park their money for a fixed tenure during uncertain interest rate movements.
TIME HORIZON Opt for long-term FMPs, say, for 3-5 years, if you are looking at high yields. You may use shorter tenure FMPs in the 3-6 month horizon if you want to take advantage of a sharp spike in short-term rates.
5 Liquid funds
As the name suggests,
these funds invest in highly liquid money market instruments, such as Treasury
Bills, inter-bank call money market, Commercial Papers and Certificates of
Deposit.
Returns on these funds are the most stable among debt funds. These provide easy liquidity and can even be used as a substitute for a savings bank account if you plan to park your surplus amount.
WHO SHOULD INVEST Liquid funds are ideal for investors who have a lot of money lying idle in the savings account and are interested in earning better returns compared to what banks offer.
TIME HORIZON Ideally, liquid funds should be used for very short investment time frame, say, as low as just a few days to a couple of months. Do not invest for a longer period as these offer low single-digit returns at best.
Returns on these funds are the most stable among debt funds. These provide easy liquidity and can even be used as a substitute for a savings bank account if you plan to park your surplus amount.
WHO SHOULD INVEST Liquid funds are ideal for investors who have a lot of money lying idle in the savings account and are interested in earning better returns compared to what banks offer.
TIME HORIZON Ideally, liquid funds should be used for very short investment time frame, say, as low as just a few days to a couple of months. Do not invest for a longer period as these offer low single-digit returns at best.
ETW140623
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