Contrary to popular beliefs, mutual funds are not limited to solely equity funds. While equity mutual funds are suitable for high-risk investors seeking high returns, debt funds are better options for risk-averse investors seeking stable returns with low volatility risks. Additionally, debt funds also offer good diversification benefits to investors helping mitigate portfolio risks and ensure capital safety. This article outlines the reasons why you should invest in debt funds to champion a stabilised and balanced investment approach.

Every mutual fund category serves a unique interest of the investor. Before investing in mutual funds, you must carefully consider the advantages each category brings to your portfolio. Here’s a list of perks debt funds have to offer:

Flexibility

Adding debt funds to your portfolio is a prudent choice because these funds are versatile investment instruments. You can invest in different types of debt funds with varying tenures to fulfil both short and medium-term goals. For instance, you can park your emergency reserves in a liquid debt fund that invests in securities with a maximum maturity period of 91 days. For medium-term goals like planning a Euro trip, you can choose short duration funds that offer maturity windows of 1 to 3 years. In simple words, debt funds allow you to invest flexibly and meet various goals.

Better liquidity

Another reason to invest in debt funds is to maximise their liquidity potential. Debt funds invest in highly liquid market-linked instruments like short-term bonds and money-market instruments. Therefore, you can easily convert your investment to cash to meet emergency requirements. While most debt mutual fund schemes may have an exit load if you withdraw before the minimum investment tenure ends, however, some debt funds do not have any exit loads.

Stability of income

Debt funds invest in fixed-income securities like bonds, debentures, CDs, and T-bills that offer stable returns. Bonds, for instance, offer returns at a fixed/floating coupon rate (except zero-coupon bonds). Therefore, even if equity returns suffer due to market fluctuations, returns from your debt fund investments can ensure stable earnings. In simple words, returns from debt funds help balance your portfolio and shield it against market volatility. This income stability is another reason to include debt funds in your portfolio.

Reduced portfolio risk

This is arguably one of the most crucial reasons to invest in debt funds. Since debt funds invest in fixed-income assets, they carry a lower degree of risk exposure as compared to equity mutual funds. Historically, when the market experiences volatility, bonds and other fixed-income assets remain more stable than equities. On the contrary, extreme volatility can result in complete capital loss in equity funds. Adding debt funds to your portfolio helps balance its risk exposure, mitigating investment risks and protecting the invested capital to a considerable extent.

Tax benefits

It is also prudent to add debt funds to your portfolio because of the tax implications of these investments. As per the amendments introduced by the Union Budget 2024, capital gains (both long and short term) from debt funds are taxed at the slab rate. However, short-term gains from equity funds are taxed at 20%. Therefore, if you are an investor who falls in a lower tax bracket, debt funds may be the better alternative for short-term investments.

• Debt funds offer flexibility to meet varying investment goals.
• Investing in debt funds mitigates investment risks in your portfolio.
• Debt funds stabilise the return potential of your portfolio.

While now you know all the reasons for investing in debt funds, make sure you consider the following factors before taking the leap:

Understand the risks

One of the chief benefits of adding debt funds to your portfolio is risk mitigation. While debt funds are less risky, they are not completely risk-free. These mutual fund schemes are susceptible to credit risk and interest rate risk. While there isn’t much you can do to avoid interest rate risk, you can minimise credit risk by investing in funds that allocate their resources to high credit-rated securities and government bonds to limit default risks.

Consider your investment horizon

There are different types of debt funds available in the market with varying tenures. From overnight funds that mature in 1 day to medium and long duration funds that mature anywhere between 3-10 years, you can choose from a wide variety of investment tenures. The key to adding debt funds to your portfolio is aligning your investment horizon with the fund’s tenure. For instance, if you have a short-term goal like buying a laptop, you can invest in ultra-short and short duration funds. For long-term goals like retirement, you can choose long duration debt funds.

Evaluate the past performance of the fund

Before you decide to add debt funds to your portfolio, you must carefully evaluate the historical performance of the fund. While past performance does not guarantee future earnings, it is still a useful way of understanding the potential yields from the fund in the last few years. Apart from fund performance, make sure you assess the expertise and experience of the fund manager and the credit ratings of underlying securities as well.

As an investor, you have a myriad of reasons to invest in debt funds. These low-risk funds are less volatile than equity mutual funds because they invest in fixed-income securities that offer relatively stable returns. Apart from risk mitigation benefits, debt funds also offer flexibility, liquidity, and tax advantages for investors to investors. So, if you are a risk-averse investor looking for higher returns than conventional instruments like FDs or simply someone looking to balance the risk quotient of an equity-heavy portfolio, you can consider adding debt funds to your portfolio.

Looking to add debt funds to your portfolio? Head to the Bajaj Finserv Mutual Fund Platform where you can compare 1000+ mutual funds in the debt fund category and make an informed choice. Apart from evaluating the past performance of these schemes, you can also estimate their returns using the free Mutual Fund Calculator available on the platform.