Investors know very well that theoretically, there is no such thing as a guarantee of perfect safety in any kind of mutual fund. Indeed, such a thing is not permissible in the rules under which mutual funds operate in India. However, the practical answer is that if you take care and choose a debt fund carefully, then there is very little reason to be worried about the safety of your money. And in the remote event that you do make some losses, they are likely to be small and temporary.
A debt fund invests in bonds and one would expect that as long as the bond issuer pays the interest and redeems the bonds when they are due, there should be no losses. Since practically all bond investments by Indian funds is in highly-rated instruments and defaults are rare.
However, bonds are tradable instruments that are bought and sold in a bond market just like stocks are in the stock market. Obviously, in this market, the prices of bonds can go up or down. When the price of a bond goes down, then the NAVs of debt funds holding those bonds will fall. If investors in that fund sell at that point, then they will could face losses.
Bond prices generally rise or fall in response to interest rate changes, or like any market, the expectation of interest rate changes. The simple way to avoid losses in bond funds is to match your period of investments with what is called the 'maturity' of the bond fund. The maturity refers to the period after which the bonds held by a bond fund will mature.
If you are investing for a short period like a few days, then go for liquid. For longer periods of investments, the suitable fund categories are progressively ultra short-term funds, short-term funds and then the medium and longer term categories. If the period of investments is fixed and you don't think you need the have the money on call, then Fixed Maturity Funds (FMPs) are best. This kind of a systematic approach, along with good fund selection, will ensure that the chance of making a loss in debt fund investments is minimised.
Things to know -Bond prices generally rise or fall in response to interest rate changes, or like any market, the expectation of interest rate changes -The best way to avoid losses in bond funds is to match your period of investments with what is called the 'maturity' of the bond fund.This article was originally published on January 22, 2014.
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