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Do you need debt funds in a portfolio?

As investors, we are constantly trying to ensure that our overall portfolio is able to balance the investment risk and generate risk adjusted returns over the long term. One way to balance risk is to diversify your investment portfolio across asset classes and money market instruments based on your risk appetite your investment horizon and your ultimate financial goal.

Mutual funds can be one way to achieve their life’s short-term or long-term financial goals. These are market linked schemes that invest in various asset classes like equity, debt, gold, etc. Mutual funds collect financial resources from investors sharing a common investment objective and invest this accumulated pool of funds across various stocks, Government and corporate bonds, debentures, commercial papers, certificates of deposits, and other fixed income securities.

While equity funds are one of the most sough after mutual fund schemes because of their potential to generate high returns over the long term, several investors also consider debt mutual funds.

What is a debt fund?

We all know that equity funds invest the majority of their investible corpus in equity and equity related instruments to generate returns. A debt mutual fund on the other hand invests in fixed income securities and money market instruments. The investment objective of most debt funds is to generate stable returns whilst protecting the investor’s capital.

Reasons to consider debt funds for your investment portfolio

Here are a few reasons why retail investors must consider adding debt mutual funds to their investment portfolio:

Low expense ratio

Unlike equity funds that have a very high expense ratio, debt funds have a relatively low expense ratio. For those who do not know what an expense ratio is, it is an expense demoted in percentage form which includes several recurring expenses like management fees, operational costs, and other similar costs that must be taken care of to ensure the smooth functioning of the mutual fund scheme. Every mutual fund scheme has an expense ratio that is deducted from the investor’s overall capital gains. A mutual fund scheme with a high expense ratio may create a void in the investor’s overall capital gains.

Stable returns

Debt funds try to generate stable returns as opposed to equity mutual funds whose investment objective is to generate high returns by taking higher risks. This way, debt funds bring in the much needed stability to the investor’s portfolio. Equity investments are volatile and returns are uncertain. However, investments in debt funds may allow the portfolio to generate stable income.

High liquidity

A mutual fund investor must consider debt funds like liquid funds as these funds offer high liquidity. A mutual fund portfolio must maintain liquidity so that investors are able to liquidate their investments in case an unforeseen exigency arises. Since debt schemes like liquid funds invest in a portfolio of fixed income securities that come with a short maturity of up to 91 days, investors can consider these for building a medical fund or an emergency fund.

Almost zero exposure to equity

The returns generated by debt mutual funds are purely based on the underlying securities in which they invest. Since debt funds do not have any exposure to stock or other equity related instruments of publicly listed companies, any upheavals in the market are less likely to affect the performance of a debt mutual fund.

Diversification

We cannot emphasize any more the importance of diversification when it comes to mutual fund investing as investors are well aware of the consequences of carrying a concentrated investment portfolio. Investors can consider debt funds for diversification. This will allow them to balance the investment risk and give them an opportunity to leverage different asset classes.