Why Investors Should Prioritize Debt Funds for a Balanced Portfolio

Over the last couple of years, debt funds have been an avenue of investment that most investors have found very attractive. The magnetic strength of stability, alignment with returns, and the factor of comparatively low risk attract not only the experienced investors but also the new entrants toward debt funds.

It is the STP or the Systematic Transfer Plan that extracts their full merit. This not only introduces financial discipline into one’s life but also allows a gradual transition into equity funds for long-term wealth creation.

Understanding Debt Funds

Debt funds are a class of mutual funds that invest in fixed-income securities, which include government bonds and money market instruments. As opposed to equity funds, debt funds offer relatively stable returns with low risks, hence being ideal for conservative investors or those seeking liquidity/low volatility in the market.

STP: An Introduction, and Its Role in Debt Funds

STP stands for Systematic Transfer Plan, and it is essentially a disciplined investment strategy. Under this, one can transfer money periodically from one mutual fund scheme to another. Normally, an STP is used to transfer money from debt mutual funds to equity mutual funds over some pre-defined period of time.

Here’s how STP works:

1. You invest a single amount of money into a debt fund.
2. A fixed amount of money or a fixed percentage over a period of time is periodically invested at stated periods like week, month, quarter, etc. in equity mutual funds.

It has the following advantages of debt fund:

• Market Risk Mitigation: Equities are highly volatile, and their market is very tough to time. Through STP, your entry into equities is made in a gradual manner, thus cushioning your portfolio against sudden market fluctuations.
• Regular Return on Uninvested Cash: The cash that is yet to be deployed in equity funds yields a regular return while sitting in the debt funds.
• Disciplined Investing: STP inculcates discipline in investing that could help one achieve much better financial growth sans the emotional biases associated with investing a lump sum during highs or lows of the market.

A Practical Example

Assume you invest Rs 10 lakh in the debt fund. At the same time, you want to set up an STP of Rs 20,000 every month into the equity mutual fund scheme. Here’s how this can be done:

That works out to roughly INR 60,000 per year from a one-time investment of INR 10 lakh at an annualised return of 6% from your debt fund.

Above 12 months, every month an amount of INR 20,000 is transferred to equity funds. Thus:

You still have INR 9.8 lakh continuing to earn interest in the debt fund at the end of the first month.

Due to periodic transfers, the balance of the debt fund falls to INR 9 lakh in the fifth month but continues to earn interest.

The result is that almost INR 2.4 lakh gets transferred to equity funds at the end of the year, and the interest on the debt fund offsets the depletion in the principal amount to an extent. Compounding returns on equity investments can also kick in for long-term growth.

Advantages of Debt Funds

Here’s why debt funds should form the base for your investment strategy, complemented with STP:

They are an asset class that is considered to have relatively lower risk. The risks involved in debt funds are minimal as compared to equity funds, thus safe and valid for conservative investors.

• Better Liquidity: Many debt funds, depending upon the type, can be liquidated without any substantial penalties; hence, they are suitable for short-term financial goals.
• Tax-Efficient Returns: The taxation on long-term capital gains for debt funds is 20%, but the added benefit of indexation comes with it. Now, although that does sound a little high, indexation brings down the taxable amount by quite an extent.

Hence, the taxation of debt funds is much lower in comparison to fixed-income investments like fixed deposits.

How to Invest in Mutual Funds Using Debt Funds

Debt Funds serve as the perfect entry point in mutual fund investments and form an ideal base for STPs.

Step 1: Choose the Right Debt Fund

The alternative would be some other debt funds, including short-term funds, liquid funds, or gilt funds, depending upon the investor’s investment objectives and his/her risk tolerance.

Step 2: Open a Trading Account

The investor opens an account with a fund house, bank, or third-party platforms such as Zerodha, Groww, or Paytm Money to start investing in mutual funds.

Step 3: Invest a Lump Sum in a Debt Fund

Invest a lump sum in the chosen debt fund. Ensure that, in the past, its performance has matched your expectations of steady returns.

Step 4: Configure STP

Choose the fund to which regular, monthly, or quarterly investments are to be transferred, as per your investment needs, and plan the frequency. Conveniently enough, this STP facility is provided to you through the platform of your fund house or broker.

Step 5: Monitor Returns

Rebalance your debt and equity funds from time to time to keep your investment strategy on course.

Approach Counts

• Market Risk: Debt funds are less risky. However, returns depend on interest rates and credit factors. Always diversify your investments to hedge against these risks.
• Exit Load: There are debt funds with exit loads in case of redemption within a certain period. Understand the terms before investing.
• Tax Implications: Understand the implication of taxation, especially for long-term versus short-term capital gains.

Overview

Debt funds come with relatively stable returns and lower risks and, hence, are suitable cornerstone holdings across different investor risk appetites. Debt funds, together with a Systematic Transfer Plan, provide flexibility, discipline, and efficiency in the phasing of market risks toward the movement of investments into equity funds for long-term wealth creation. In this way, in their quest to know how to invest mutual fund, debt funds present an intelligent entry into equities for gradual exposure while maintaining portfolio balance.

The yields on debt funds generally remain stable, thus making the portfolio efficient and less volatile than in case of direct equity investment. Investing through debt funds is considerably easy and can even be customized in such a way as to achieve several investment objectives. In this respect, one could avoid risks and also safeguard the returns that have been accrued from debt funds by transferring money into equity funds systematically over a certain period of time.

Disclaimer

The content reviewed in this document should not be considered financial advice. You should consider factors such as your priorities, flexibility with risk, and current market conditions before executing an investment in debt or mutual funds. You should also consider the advantages and disadvantages to the Indian financial market before investing. The past is not an indicator of future performance; therefore, you should seek out a registered investment advisor before deciding on any financial action.

Also Read: Top Benefits of Using a Financial Debt Consolidation Company

💬 FAQs about Debt Funds

What are debt funds?

Debt funds are mutual fund schemes that invest primarily in fixed-income securities such as bonds, treasury bills, and debentures to offer stable and consistent returns.

Why should investors prioritize debt funds?

Debt funds help investors reduce portfolio risk, maintain liquidity, and generate predictable returns, making them ideal for conservative and balanced investors.

Are debt funds safer than equity funds?

Yes, debt funds are generally less volatile than equity funds since they invest in interest-bearing instruments, but they still carry credit and interest rate risks.

How do debt funds provide returns?

Debt funds earn returns through interest income and potential capital appreciation when bond prices rise due to favorable market conditions.

Who should invest in debt funds?

Investors seeking steady returns, low risk, and short-to-medium-term investment options can benefit from adding debt funds to their portfolios.