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Using Debt Funds to Provide Stability

Debt funds play an important role in an equity portfolio. They can make your portfolio more stable


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Using Debt Funds to Provide Stability

Debt funds can play an important role in an equity portfolio, something which a lot of equity investors do not know or understand. Asset rebalancing must be the most useful and yet the most ignored of ideas in the world of investing. However, it's actually very easy to implement for mutual fund investors.

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Asset rebalancing means that instead of seeing the equity-vs-fixed question as a black-vs-white binary choice, you should be seeing it as a shade of grey. Based on the time horizon of your financial needs and your risk tolerance, you could decide to some percentage of your financial investments in equity and some in fixed income. Once every year or so, you could 'rebalance' your portfolio. What this means that if the actual balance has veered away from your desired one, you should shift money from one to the other in order to attain that percentage again.

When equity is growing faster than fixed income--which is what you would expect most of the time--you would periodically sell some equity investments and invest the money in fixed income so that the balance would be restored. When equity starts lagging, you periodically sell some of your fixed income and move it into equity. This implements beautifully, the basic idea of booking profits and investing in the beaten down asset. Inevitably, things revert to a mean, and that means that when equity starts lagging, you have taken out some of your profits into a safe asset.

The real benefit of this is seen only when the markets start falling and the value of the equity portfolio starts declining. Even though the equity part of this portfolio would fall when the market falls, the equity profits that have been already been moved into debt funds would not fall.

Of course, it's a lot of hard work to implement this concept. Balanced funds (also called hybrid funds) can do this automatically for you.

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