What You Need to Know About Investing in Debt Mutual Funds

Adobe Stock

Investing in mutual funds is becoming popular, and one such fund is debt mutual funds. Here are a few things to consider and look for when you are considering investing in these low-risk mutual funds.

What are debt funds?

Debt funds are a type of mutual funds in which most of the money from investors is put into fixed income instruments such as central government and state government bonds, certificates of deposit, treasury bills, corporate bonds, and bonds issued by banks, according to financial express.

As these are considered a low-risk type of mutual fund, they are one of the best options available for those looking for safer investments.

Choosing a debt mutual fund

Debt mutual funds are different than equity mutual funds. Investors will need to consider the following essential, basic steps, before choosing a debt mutual fund.

1. Check the credit rating

Credit rating is essentially a way of predicting the probability of the debtor defaulting and you are not recovering the money. Think of it like a restaurant rating–anything above 3-star will be good. Some ratings, such as AAA, signify the highest ability to repay, going down to D, which indicates default by the issuer.

If you don’t want to bear a high credit risk, look for funds that invest at least 80% of the portfolio the highest-rated bonds.

2. Check the average maturity

Maturity is the length of time that the principal will be paid back in interest payments will cease, according to Clear Tax.

As a rule of thumb, look for low volatility and and plan to keep your money in the investment for “short-term” 1-3 years, rather than the longer “intermediate term” 3-10 treasury bills years. Then, look for average maturities that will match your investment horizon. The longer duration, the more sensitive returns from the fund will be to changes in interest rates.

For example, if rates rise 1%, a fund with a 5-year average will theoretically lose 5 percent of its value, Fidelity reports.

3. Consider the exit load

The exit load is a penalty and investor pays if they exit or withdraw from a mutual fund. The fee is a percentage of the amount invested. Take note of the exit load when picking a mutual debt fund. If you think you might need your money after 4-5 months in a fund, make sure not to choose one that has an exit load for withdrawals before 1 year. Otherwise, the penalty could wipe out any gains.