Don’t let the jargon of debt funds fool you into investing most of your capital in it. Because to be clear, debt funds are not fixed-income funds and you can even procure losses in investing in debt funds. Yes, it is possible! Until now you must’ve thought that debt funds are quite safe and have neither risk nor volatility. Don’t take it for granted. Even the net asset value of (NAV) of debt funds can crash and you may end up losing gains of the entire year.
Yeah! Debt funds have a fair advantage over fixed funds as they offer high liquidity and tax-efficiency than fixed-income deposits but when it comes to safety fixed-income funds are far more secure than debt funds.
Here we’re going to discuss the instances at which an investor can procure losses while investing in debt funds.
Common Reasons Behind Losing Money in Debt Funds
The most common reason behind losses in debt funds is the daily fluctuation in the instruments that a fund holds. When the debt market falls, it can generate a loss. Generally, the debt market rises or fall based on the interest rate movements or expectancy that interest rates will change.
The less common instance is when the credit rating of an instrument that a fund holds downgraded and the instrument also listed in the market.
On rare instances, when a financial instrument that a debt fund holds has defaulted, the fund must reset the instrument’s price to market price. However, it is very rare to see that happening but when it does it results in a fall in net asset value (NAV).
Note: – Fall in market prices and NAV doesn’t mean your fund is delivering losses. It’s just a paper loss, not an actual loss unless you sell the fund at that time.
Besides, as per mutual fund disclaimer – mutual fund investments are subject to market risks-the reference is not limited to equity mutual funds but also to debt funds and other types of mutual fund schemes.
You can lose money in debt funds. Impact of changing in interest rate is very clear in the case of debt-oriented funds. Any change in interest rates can affect a wide range of financial products, from bonds to bank loans. For instance, if the interest rate increases, the bond funds will decrease in value since higher coupon rates will bring down the value of older bond funds however if the interest rate declines, the bond funds will increase in value. But, even that is for the short-term. The actual value of a debt fund is determined by the net asset value (NAV). Any unreasonable change in interest rate could significantly move up or down the net asset value.
So, if you’ve decided to invest in debt funds or planning to, we would suggest you give some thought to the time frame. A time frame is important when it comes to getting the best out of your investment.
In a nutshell, debt funds do deliver losses but if you step forward smartly you can actually minimize the losses and make better returns throughout the years even in debt funds. Debt funds are the best way to diversify your investment portfolio. Not only it mitigates risk but helps in diversify investments. Besides, there is no TDS in debt funds if you can hold onto your investments for three years, you can avail indexation benefits and reduce the tax outflow.
But, make sure you understand every reason we’ve mentioned here. It will allow you to handle every possible circumstance while investing in debt funds. Not only you can avoid the sudden losses but also able to manage and make potential returns from your investments.
Hope, this article helped you in understanding how debt funds can deliver losses? – Nevertheless, if you have any query or would like to suggest something then please don’t forget to mention in the comment section below.