Do you want to learn about Debt Mutual Funds Basics in simple and easy-to-understandable language? From this post, I am starting to publish a series of posts that may help investors to understand the basics of debt mutual funds.
Many of us are investing in equity mutual funds. However, when it comes to debt mutual funds, what I noticed from my own experience with clients is that they stay away from debt mutual funds investing. The primary reason is they are unable to understand debt mutual funds or they feel a little bit complicated.
Let us first try to understand why we need Debt in our portfolio.
Debt Mutual Funds Basics
Before randomly trying to understand the basics of debt mutual funds, it is important for all of us to know why we need a debt portfolio.
Need for a Debt Portfolio
“Let every man divide his money into three parts, and invest a third in land, a third in business and a third let him keep by him in reserve.” So it is written in the Talmud, a record of debates among rabbis about Jewish law dating as early as 1200 B.C. And so it is written on Page 1 of Asset Allocation: Balancing Financial Risk by Roger Gibson, first published in 1989.
Asset allocation is not new to us. However, we forget to implement it mainly because many of us try to chase the returns. When we are actually unaware of which asset class will perform better in the future and how volatile the asset class is (especially equity and gold of kind of assets), it is imperative for all of us to have a diversified portfolio to reduce the risk.
The importance of asset allocation is again validated by few whom I enormously admire to upgrade my investment knowledge. One such person is William J. Bernstein (Author of the book “The Four Pillars of Investing).
“In short, during the next 20 or 30 years, there will be a single, best allocation that in retrospect we will have wished we have owned. The only problem is that we haven’t a clue what that portfolio will be. So, the safest course is to own as many asset classes as you can; that way you can be sure of avoiding the catastrophe of holding a portfolio concentrated in the worst ones. – William J. Bernstein, The Four Pillars of Investing.”
As asset allocation is a NEED for an investor, a debt portfolio is obviously a primary important asset class like equity (or gold or real estate), understanding how to build our debt portfolio is of utmost importance.
As mentioned above, there are many lags in creating a well-diversified debt portfolio. Mainly because they feel it is little bit cumbersome to understand and implement. To address this issue, I thought to write a series of posts that will simplify your debt portfolio implementation.
I will try to address what should be your ideal asset allocation of debt to equity at a later stage. Now let us discuss certain important points you have to consider before starting your journey of including debt mutual funds in your portfolio.
# Your Debt Portfolio is meant to create a cushion for your overall portfolio and create downside protection rather than creating high returns for you.
# You have already taken a risk of volatility by investing in equity. Hence, the purpose of a debt portfolio is to reduce the risk.
# If you try to look for returns (in the bond market it’s called yield) from your debt portfolio, then the whole portfolio looks like a bomb. When and which asset class will explode we don’t know.
# Try to use as simple as possible and understandable products for your debt portfolio.
# Hence, I always prefer Bank FDs, RDs, SSY, PPF, EPF, VPF or SCSS kind of products (based on suitability).
# If you still have room to invest in debt or the above-mentioned products are not suitable for your goals, then we can explore debt mutual funds.
# Like equity, here also Mutual Fund companies are bombarded with various categories of products. The idea for them is to offer as many products as possible. This creates huge confusion among investors. However, to be frank, we don’t need 99.99% of the products they offer.
# Hence, my idea going forward is to concentrate on simplifying your debt mutual fund selection and choosing 0.01% of the products.
In the next blog post, I will explain to you certain advantages and disadvantages of debt mutual funds. In this post, I kept it mainly to give an introduction or for what purpose you have to choose debt mutual funds.
Read the next parts of these series –