Do’s and Don’ts of Debt Mutual Fund Investing

Here are some simple steps to avoid mess-ups when it comes to investing in debt mutual funds. Freefincal has 30+ posts on debt mutual funds. It is high-time that I compiled them into an e-book. I need to finish a couple of posts before I can do that. This is one of them.

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If you are an absolute beginner, you can start here:  What is a Debt Mutual Fund?.  The second part is here: What To Look For When Buying A Debt Mutual Fund. All debt fund posts are listed here.

This post is a summary of the basic precautions to take while investing in debt funds. Each of these points has been covered in detail before.

1 Do not assume debt funds will beat fixed deposits

This is how debt funds are sold. That does not make it true. A debt fund is a market-linked product and unless you know how to categorise them in terms of risk, you should not be investing in them or in any product for that matter.

There are times when debt fund returns will be more than a fixed deposits and times when it will be less. See the rolling returns study to see this for yourself.

2 Do not take past performance seriously

This is more true for debt funds than for equity funds! Just a few months ago, so many people thought they could invest in liquid funds and get 9% return! How many of them knew this was because of the propelled because of bonds crash in July 2013? (Yes, bonds can crash like stocks!) Check out how long it took for my NPS to recover.

NPS June 2014 - Do's and Don'ts of Debt Mutual Fund Investing

In a healthy economy (something absent from close to 10Y now), the short-term rates would be lower than long-term rates. So if your liquid funds give you good returns, you should pray that the party ends soon!

3 Do not choose funds by returns or ratings!

A consistent outperformer in the debt fund space does not make it a good buy! It is crucial to understand what risk premium stands for. A debt fund giving more returns than other in a category could only mean one thing:  it is taking on more risk. This risk could be associated with interest rate movements or it could be buying bonds of lower credit quality.

There is nothing wrong with the fund manager taking on more risk. Question is, were you aware of what this means before you purchased the fund.

Debt Mutual Funds: Credit Risk and Interest Rate Risk Can Co-exist!

4 Not for Lazy People

Debt mutual funds are suitable only for those who can spend 15 minutes of their busy lifestyle to read the scheme information document.

5a (Try  to!) Buy Style-pure funds

Style purity refers to a fund which sticks to clear investment style. I like funds that will only invest in X,Y,Z type of bonds or will not invest in X,Y,Z bonds. Of course one will know this only if one bothers to read the scheme information document. This is not easy, hence the “try to”.

5b Debt fund “categories” is a joke!

As I will show in the next post, debt fund categories is a joke. Each can be very different within the same category. So once you decide the category to invest in, make a short list, study each scheme document and pick a style pure fund.

6 Most advice in the debt fund space is plain crappy.

Here are some don’ts:

Poor Debt Fund Advice: Match Investment Horizon With Fund Maturity Profile

Do not invest in dynamic bond funds!

My posts belong in this space too. So do your diligence.

7 Buy debt funds only if you need them

Ignore all calls from the mutual fund industry to make your money work harder (for them!). Use debt funds only if you need them. That extra 1% return over a few months or even a few years will not make you a rich person. Use FDs, RDs and focus your energy on long-term goals, other hobbies and some peaceful sleep. Even for a long-term goal like retirement, there are other alternatives like PPF or EPF/VPF.

What should a new debt fund investor do

a: stick to liquid funds for requirements ranging up to a  year or so.

b: above that, stick to ultra short-term funds that invest in banks and psu bonds.

Debt Mutual Fund Selection Guides

How and When To Select Ultra Short Term Debt Mutual Funds

Smart Ways to Invest in Corporate Fixed Deposits

How to Select Mutual Fund Fixed Maturity Plans (FMP)

Should I buy Long Term Gilt Mutual Funds?

How to choose debt mutual funds with no credit risk and low volatility

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One thought on “Do’s and Don’ts of Debt Mutual Fund Investing

  1. Pattu,

    Good post. Need some clarification on Point 7.

    “Use debt funds only if you need them. That extra 1% return over a few months or even a few years will not make you a rich person. Use FDs, RDs and focus your energy on long-term goals, other hobbies and some peaceful sleep.”

    I have been investing about 2 lakhs in FD for many years now apart from MF, PF, PPF, liquid funds.
    The rates have been coming down from 9.25 to 7.25 now.
    If debt funds could give about 9% returns over 5 years, would it not be worthwhile to invest in debt fund or continue with FD @ 7.25%.

    Thanks,
    Rakesh

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