Most investors have the perception that it is easy to pick debt funds than equity fund. But it is actually vice-versa. There are a lot of aspects that you, as a prudent investor, need to look into so as to not lose out on your savings and enter into a debt of a personal loan or a credit card loan to repay your finances or fulfill your financial requirements.
Time horizon
Most financial advisors hail to match your financial goals with your investments. It is very important for you to link you financial goal to the tenor of your investments. This is so because it will save you from any any charges for a premature withdrawal of your funds and will give you the funds as and when you required. For example if you want to fulfill your financial which is about a 100 days away, investing in an ultra short term fund of 90 day maturity period can benefit you.
Quality of underlying paper
The quality of debt instruments in the fund’s portfolio should be scrutinized closely. Each instrument is assigned a credit rating that signifies the level of default risk. The higher the rating, the safer the instrument. Go through the offer document as well as the subsequent fact sheets published by the mutual fund. A debt fund may invest in several instruments, ranging from risk-free government securities to high-risk corporate paper.
A fund holding large amounts in a poor quality paper may find it difficult to sell such securities in the market, thereby putting your money at risk. While a debt fund with a risky paper is likely to yield higher returns, it may work unfavorably for the investor. As the safety of capital is of utmost importance to a debt investor, one should not go for funds with low quality investments.
Interest rate scenario
It is important to understand to the inverse relationship o the interest rates on your debt funds. If the rates rise, debt funds lose value, and vice versa. Short-term debt instruments are less sensitive to rate movements compared with the long-term ones. So, when interest rates are on the rise, it makes sense to move to short-term funds, and vice versa. Liquid funds provide the least risk, followed by liquid plus funds. The funds bearing marked-to-market risk, such as income funds or long-term gilt funds tend to underperform in a rising interest rate scenario over the medium to long term.
Expense ratio
It is very important to choose those debt funds that have a low expense ratio. If a debt fund promises you high returns but has high expense ratio, it is likely to consume most of your returns.
Size of the fund
Debt fund faces large-scale redemptions which a small corpus may not be able to meet this demand. A large corpus will stand in good stead for the fund manager as he will be in a better position to sell securities in order to cope with the redemptions. A large fund can also meet such needs from its cash pile without having to sell its holdings. The fund manager of a much smaller scheme will not enjoy such flexibility. He may be forced to book losses on some of the holdings in order to meet the redemption pressure, which will be done at the cost of your savings.
Apart from all these factors that need to be reviewed factors like the same basic criteria-risk profile, consistency in performance and fund manager’s track record-across all categories, also need to be examined.