Read on to know the category of debt funds that is recommended for optimum asset allocation between debt and equity
Which category of debt funds is most suited for asset allocation between debt and equity? - S K Sharma
Asset allocation is still an important consideration when investing in financial securities. While equity provides superior returns to investors over longer time periods, it is subject to volatility. Debt, on the other hand, can provide some portfolio stability while yielding lower returns.
Relation between interest rates and returns
Investors should be aware that changes in interest rates affect the returns of debt funds. There is an inverse relationship between bond prices and interest rates. When interest rates rise, bond prices fall, and bond prices go up when the interest rate regime is in a downward trajectory. The longer the duration of the debt fund, the more volatile they become in nature.
Which debt fund category to choose?
Within debt mutual funds, there are multiple options available in front of investors depending on their risk profile.
However, it is not advisable to invest in funds that are long-term in nature, like long duration funds or gilt funds. Such funds react quickly to the changes in the interest rates and are highly volatile.
Going the hybrid way
Investors can also look into hybrid funds as they are easy to understand and provide the advantage of automatic rebalancing of portfolios. Now, there are multiple hybrid funds available to the investors.
In fact, asset allocation through hybrid funds can be done in a more tax-efficient way. This is because when a fund house sells the security to rebalance the portfolio, there is no capital gains tax. However, if the investor manually rebalances the portfolio, transactions will be applicable for capital gains tax.
Suggested read: How do I decide my asset allocation?