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Don’t make these three mistakes when picking a debt fund

From not having a purpose for your investments to going only for returns, here are the three mistakes you should avoid making when picking a debt fund

There are at least 15 different categories of debt funds available for you to choose from. Undoubtedly sifting through these to come up with the few you need is going to be a daunting task. As a quick check to ensure accuracy in the selection, avoid making these three mistakes. 

1. Not having a purpose 

As a first step clearly define the reason you are looking for a debt fund. It could be that you want some stable allocation for generating regular income. Or it could be that you want to balance your portfolio risk and add some long-term fixed income allocation to your overall portfolio. Or it may be that you want to invest for a very short period of time so the need of the hour is low risk and stable return which a debt fund can provide. 

Unless you have defined the purpose or the goal of your allocation, you will end up making a mistake with the choice of funds. For example, a short-term income fund which in turn invests in debt securities with a 2 to 3-year maturity will not suit your 3-month investment requirement. For the latter, you must look at the liquid and ultra-short-term category in debt funds. 

Knowing the purpose of investment, helps you match your time horizon for the investment with the maturity profile of the underlying securities in the fund portfolio.

Keep it simple if your debt fund investing is about the stability of returns, look at picking schemes with portfolios that are high quality even if that quality comes at the cost of return.

2.  Going only for returns

Once you have decided the broad categories of debt funds that you are interested in, the next step is to narrow down funds within a category. You can do a simple sort by returns and pick the highest return fund, after all we invest to earn returns. However, in the case of debt funds,  a high return is not always the right return. Within a category, the variance in return could be a result of abilities in active fund management or higher risk in the portfolio. This high return can come at the cost of the quality, which can also lead to losses. 

Keep it simple if your debt fund investing is about the stability of returns, look at picking schemes with portfolios that are high quality even if that quality comes at the cost of return.

3. Ignore the average maturity of the portfolio

While you may have narrowed down the fund category that works for you depending on the general maturity profile of the schemes in the category, you should also check the average maturity of the scheme you want to invest in. In general, a short-term income fund should have an average maturity between 2 to 3 years, but there are those which will either be much lower or much higher. In both cases, there is a risk – either of low returns or the high duration which can increase volatility in returns over the period of your investmen

Debt fund investing is not the same as buying a fixed deposit. However, given that returns are a lot more efficient, this is a space you can’t avoid. If all these factors seem too hard to follow, then choose a good advisor and ensure they are able to bring this selection to you after the proper due diligence.

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