Debt mutual funds form an important part of any investment portfolio. By investing in fixed income securities and different money market instruments, these funds offer stability, predictability, and income to your portfolio. Most importantly, debt funds help to balance the risks of other investments.
There are many types of debt mutual funds, but two major categories are short term and long term debt funds. Short-term debt funds invest in securities with a maturity of 1-3 years, and long-term debt funds focus on securities with maturities over 3 years. The duration affects the level of risk you can take and the potential for returns.
So, should you go with short- or long-term debt funds? Here are the key differences between these debt funds that can help you invest wisely as per your investment goals, risk appetite, and time horizon.
- Interest rate risks
The longer the maturity of debt funds, the more the risk. So, long-term debt funds incur more interest rate risks as they have more exposure to the interest rate fluctuations. Short-term debt funds are less sensitive to interest-rate changes because chances of sharp movements in interest rates in the short term are usually low. So, the risk of loss due to interest-rate fluctuations is much lower.
- Risk tolerance
Long-term debt funds are more volatile than short-term debt funds. This means that investors who can take more risk and wait for more than 3 years to see returns can add these funds to their portfolio.
Short-term debt funds prioritise stability and liquidity, thus, have less risk. These funds are ideal for risk averse investors who prefer quick access to their funds.
- Investment goals
Short-term debt funds help with short-term goals like creating a large emergency fund or saving for planned expenses within 1-3 years.
Long term debt funds work for investors looking to invest their money for a longer period, typically 3 years or more. These investors can choose from different debt funds types, such as dynamic bond funds and gilt funds.
For example, let’s say an investor wants to park money for a maximum of three years for a specific financial goal. Here, short-term debt fund investments would be ideal to get stability, liquidity, and decent returns, with the added bonus of the capital being protected.
Long-term debt fund investments would be useful for someone who can lock their money for more than three years for a higher return.
Choosing the right debt fund for your mutual fund portfolio needs a thorough evaluation and analysis. Assess your financial situation, risk tolerance, and investment goals before investing in debt funds. The selection process should include reviewing the funds’ cost structure, credit quality, historical performance and returns consistency.
Debt fund investments also carry interest rate risk, credit risk, and liquidity risks, so taking financial advice from experts is important. They can give you valuable insights into market trends, investment options, and risk management strategies. With their professional guidance, you can identify the right debt funds and create an appropriate strategy to achieve your financial goals while minimising investment risks.