Understand the Risk of Debt Fund Investment

By Tori 4 years ago

If you are someone who is not satisfied with the capital appreciation your current conservative schemes are offering and looking to switch to other avenues, you can consider investing in mutual funds. The beauty of mutual funds is that they carry a diversified portfolio. Mutual funds give investors an opportunity to seek profits from various types of markets, industries and asset classes. For example, if you are someone who has been investing in physical gold for many years and only seek capital appreciation by investing in this shiny asset, you can invest in a gold mutual fund. You do not have to pay for any making charges, do not have to worry about theft since gold funds are a digital investment tool and yet, you continue investing in gold whose purity is ranked as per international standards. Another good thing about mutual funds is that one can invest small amounts through SIP. Investors can use an online SIP calculator to determine how much money they need to invest regularly to achieve their goals.

Now isn’t that a smart and contemporary way to invest and seek capital appreciation? The primary reason most of us invest is to make some profit in the long run. But investors should understand that like all investment schemes, mutual fund investments carry risk too. There are multiple mutual funds that carry a different degree of risk depending on their investment objective and nature of the scheme. For example, equity mutual funds invest predominantly in equity and equity related instruments. Equity markets are constantly exposed to the market’s volatile nature. Hence, investments in equity mutual funds carry a large amount of risk. Investors should always determine their risk appetite before investing in equity mutual funds.

A lot of investors who do not have a large risk appetite generally prefer investing in debt mutual funds. While equity funds invest predominantly in equity and equity related instruments, debt mutual funds invest in debt instruments and fixed income securities that generate regular income. Although debt funds may not be able to offer capital appreciation like the way equity funds do, they are generally considered by investors who carry a low risk appetite and are looking for steady income. But this doesn’t mean that one should consider debt funds to be completely risk free.

Although debt funds are not as volatile in nature as equity mutual funds, they do carry a certain degree of risk. Here are some of the risks that are associated with debt funds:

Credit Risk

A credit risk is nothing but the fear of the borrower failing to pay the interest rate on a date committed. This is also referred to as default risk. CRISIL is one of the rating agencies that gives borrowers ratings like AAA+, AAA-, etc. depending on the financial health of the issuer to determine their ability to repay the promised interest. However, investors should understand that the credit risk of a company will not remain stagnant. Depending on its performance, the company’s credit risk appetite may increase or decrease.

Interest Rate Risk

Investors should understand that the market price of a bond and the interest rate always go in the opposite direction as they are inversely related. When the value of the bond in the market goes up, its interest rate goes down. Income funds and gilt funds are some of the mutual funds that are considered to carry high interest rate risk.

Now that you understand the risks that are involved with debt mutual fund investments, make sure that you take these into consideration while making an investment in debt schemes. If you feel that you need further assistance, then feel free to consult a financial advisor.