Why debt funds are important for your mutual fund portfolio?

Why debt funds are important for your mutual fund portfolio?

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When it comes to mutual fund investment, most retail investors think of equity mutual funds. The low wallet share of debt mutual funds is primarily due to lack of investment awareness. However, mutual fund investors should know that debt mutual funds offer solutions for wide range of investment needs. Debt funds are also known as fixed income funds.

Why debt mutual funds are important for your portfolio?

Asset Allocation: Asset allocation is the mix of your investment portfolio in different asset classes like equity, fixed income, gold etc. It is the most important aspect of investing. Debt mutual funds are lower risk assets compared to equity mutual funds in India and play a vital role in ensuring optimal asset allocation.

Ideal for short term goals: Asset allocation aligns your portfolio to financial goals across different time horizons, e.g. short term, medium term and long term goals. While you can afford to take high risks for long term goals, you want low risk for your short term goals and thus debt funds perfectly fit into that slot.

Risk diversification: If your mutual fund portfolio comprises entirely of equity mutual fund schemes, a bad bear market can wipe out returns of many years. Therefore, having both in your portfolio ensures that the equity portion though volatile ensures superior market linked returns while debt mutual funds provide overall portfolio stability and income in all market conditions. Thus, risk diversification enables you to remain invested for longer periods of time and enhance your returns.

Superior returns: Debt mutual funds are market linked investments and therefore, do not assure returns like traditional fixed income investments. However, if you look at 1, 3 and 5 year returns of some best debt mutual funds categories you will see that debt funds have outperformed savings bank and FDs on a pre-tax basis.

Debt Fund Category Returns (%)
1 Year 3 Year 5 Year
Liquid Funds 3.12 4.9 5.66
Low Duration Funds 4.62 4.33 5.29
Ultra Short Duration Funds 3.87 5.74 6.15
Overnight Funds 3.02 4.24 4.89
Money Market Funds 3.63 6.06 6.36
Short Duration Funds 4.96 6.28 6.24
Medium Term Funds 8.01 5.46 5.83

Source: Advisorkhoj.com

Liquidity: Debt mutual funds provide superior liquidity to your portfolio. Money market mutual funds like overnight fund and liquid funds have no exit load, they can be redeemed at any time. Other types of money market mutual funds like ultra-short duration funds, money market funds etc. also have short exit load periods and are more liquid compared to other mutual fund schemes.

Tax Advantage:  Debt mutual funds enjoy considerable tax advantage compared to bank FDs over 3 years plus investment periods. While banks FD interest is taxed as per the income tax rate of the investor, while investment held for more than 3 years in debt funds are taxed at 20% after allowing indexation benefits. On a post-tax basis, fixed income funds are likely to give much superior returns than bank FDs.

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