Don't make this financial mistake now!

I’ve met a lot of folks recently who say that because the market is volatile now, they’re considering switching to Debt Mutual Funds because, well, they’re “safe” and “not volatile”.

Well, here’s the thing - while most debt funds may seem to be less volatile than equity, not all of them are safer. And they’re also not always less volatile. To understand why, you’ll need to first understand a little bit about the debt market and how debt funds work. Don’t worry, 5 minutes is what it’ll take you to read this whole thing, so let’s get started!

So first let’s see where Debt Funds invest money (before that, if you don’ know how mutual Funds work, quickly read it here).

Well, depending on the type of fund, debt funds invest money in “Fixed Income” products. What are fixed income products, you ask? Well they’re products that, as the name suggests, give you a fixed income. A Fixed Deposit is the simplest fixed income product. Other fixed income products include things like Bonds, Commercial Papers, Certificate of Deposit and a lot of other technically complex, jargon-filled products (which we won’t discuss here).

Now, debt funds primarily invest in bonds (and other fixed income products). So to understand why Debt Funds are also risky and volatile, you need to understand what bonds are and how they work (If you know how they work, you can skip the next 3 paragraphs)

Let’s take a government bond for example. The government issues bonds which you can invest in. A bond is a piece of paper, which you will buy from the government. This means that people like you and I give money to the government and the government issues the bond to you. For this money, the government gives you a you a fixed interest every year (known as the coupon). Now each bond has a period after which the issuer will return the money to you. This period is known as Maturity. So after the bond matures, you will get the face value of the bond back. Notice here, that the coupon, as well as the face value that you’ll get back is fixed at the time you purchase the bond. Hence a bond is a “fixed income” product.

(We just took an example of a government bond. Bonds can be issued by corporate companies too. If you still want to read more about bonds, you can read about them HERE)

Now here’s where things get interesting! Bonds trade in the bond market (just like stocks trade in the stock market), and their price keeps fluctuating based on a lot of factors (we’ll keep the factors for another day. For now it’ll suffice to know that bonds can be traded and their price keeps fluctuating)

Well, coming back...

Haan, so when you invest in a debt fund, it invests in debt products like bonds, whose prices fluctuate like stock prices. Though they’re not as volatile, they still fluctuate. So the NAV (or price) of one unit of your debt fund is dependent on the prices of the underlying bonds. If the bond prices fluctuate, your fund’s NAV fluctuates.

How then, would you think that a debt fund is NOT volatile? It 100% is.

Now, let’s look at RISK of debt funds

Alright, so now that you know how bonds work, I’m sure you can guess that there could be a scenario where if you’ve purchased a corporate bond, the corporate could go bust or default on their coupon payment. And if that happens, you lose money.

So now if a debt fund has invested in such a corporate bond, its NAV will take a hit if the corporate defaults. Now, let me be clear: Such defaults are very rare, but they do happen. Also, not all debt funds invest in such risky bonds. All bonds have a rating given by rating agencies. Higher the rating, safer is the bond. But to earn higher returns, some debt funds may invest in lower rated bonds as well, and that opens up a risk for you as an investor.

In fact, default risk is just one risk. Another major risk which debt funds face is Interest Rate risk. We won’t get into details, but increasing the interest rates by the RBI (which happened twice recently) actually lowers bond prices, which means it lowers your fund’s NAV.

Point is - while Debt Mutual Funds may be less risky and less volatile compared to Equity Funds, all debt funds are not risk-free. So don’t blindly invest in debt funds just because the stock market is volatile. You need to understand how Debt Funds work before investing in them!

And don’t worry, I’m there to help! Over the next few newsletters, we’ll discuss debt funds and fixed income investments in detail (and next Sunday is going to be interesting for this exercise).

Now, “where do I invest in, given the current scenario Ankur?” you may ask!

For that, I’m doing a webinar on the coming Sunday (10th July), where we’ll talk about the best products to invest in, given the current market conditions.

If you’re someone who wants to learn more about, and invest in, some really interesting products for this current market, quickly fill up this form and let me know your available timeslots! And if you don’t want to invest, just drop by and say hi! I’d love to have a face-to-face interaction with our community, and you’ll also be able to meet fellow enthusiasts like yourself!

[This webinar was supposed to be conducted today, but unfortunately, it couldn’t be done. So the date has been rescheduled to 10th July. My apologies to all those who had registered for today! 😞 But I promise I’ll make it up to you next weekend! See you guys there! 😁😁]

PS: If you enjoyed reading this post, please LIKE it and share it with friends on WhatsApp! And if you’re not reading this on email, why don’t you subscribe to this newsletter by hitting the button below?

See you guys next Sunday! Excited main edda 😉