Do you know, historically, many Indians have invested a significant amount of their money in bank fixed deposits as a primary financial alternative? On the other hand, gold and real estate remain attractive tangible assets to invest in. However, in modern times, we have become more conscious of investing and asset allocation.
We are also witnessing the rise of financial and capital markets and the emergence of new investment opportunities like Cryptocurrency, P2P Lending, Index Funds, Arbitrage Funds etc. So, are you a relatively younger investor with a longer time horizon? Are you willing to take on greater risk in exchange for possibly more significant rewards? If this is the case, then an 80/20 allocation may be appropriate for you.
This indicates that 80% of your portfolio is invested in growth assets like equities, with the other 20% allocated to more cautious fixed-income choices like bonds and cash. As retirement approaches, risk tolerance often diminishes. In this situation, a 70/30 allocation (70 per cent equities and 30 per cent other fixed income securities) may be more appropriate.
Fixed-income investments include bonds, fixed deposits with high interest rates, and debt mutual funds. Bonds include lending money at an agreed-upon interest rate, which is subsequently returned at maturity.
Fixed deposits function similarly – Banks deposit money and provide interest until maturity. Debt mutual funds also work on this principle only, except they pool investors’ money into various bonds via the MF (mutual fund) scheme.
Don’t worry if the notion of these financial alternatives is making you scratch your head. This blog explains everything in simple words so you can make educated decisions about your financial future. So, take a cup of coffee, get comfortable, and let’s explore the intriguing world of bonds and debt mutual funds!
Table of Contents
What are Debt Mutual Funds?
Debt mutual funds are investment vehicles that focus on fixed-income assets such as government bonds, corporate bonds, treasury bills, and other money market instruments. These funds are regarded as a safer investment alternative than stock mutual funds since they provide a consistent income stream while posing less risk.
One of the primary benefits of debt mutual funds is the diversification and expert management of such funds, making them an appealing alternative for conservative investors. While debt funds provide stability, they are not without risk, as they are exposed to interest rate volatility and credit risk.
Overall, debt mutual funds can be a valuable addition to your investment portfolio, especially if you are looking for a more stable and predictable source of income.
How Do Equity and Debt Mutual Funds Differ?
People often get confused between equity and mutual funds. But they differ drastically. Equity mutual funds are like a mixed basket of fruits, with apples (stocks) for growth, oranges (bonds) for stability, and bananas (cash) for liquidity.
Debt mutual funds, on the other hand, are more like a basket full of oranges – They provide a consistent source of income while posing less risk.
If you want to invest in stocks and securities as well as bonds for stability, equity mutual funds may be your best option. However, if consistent income from government securities or corporate loans or securities appeals to you while posing less risk, debt mutual funds or bond fund investments may be worth investigating.
What are Bonds?
Bonds are tradable fixed income securities issued by governments, municipalities, or companies to fund specific projects or activities. When you purchase a bond, you are effectively lending your money to the issuer in exchange for periodic interest payments and the repayment of the bond’s face value when it matures.
It’s like being the lender rather than the borrower. Bonds can be an excellent method to diversify your investment portfolio while potentially earning a stable income. Furthermore, they are less volatile than stocks. So, they are attractive options for more cautious investors.
Click here to know more about bonds
What are the Differences Between Mutual Funds and Bonds?
Credits: Freepik
Bonds are essentially debt instruments issued by entities such as corporations or government organisations for a specific length of time. Debt mutual funds, on the other hand, are mutual funds that invest in debt instruments such as bonds, debentures, commercial papers, and other fixed-income assets.
To explain the difference between mutual funds and bonds in layman’s terms, investing in debt mutual funds is similar to taking an indirect approach to bond investment.
If you have particular fixed investing needs, it is typically recommended that you invest in Bonds rather than debt mutual funds. For a quick comparison of the two choices, check out the bonds vs mutual funds table below!
Debt Mutual Funds vs Bonds
| Aspect | Debt Mutual Funds | Bonds |
| Returns | Debt mutual funds are not strictly fixed-income products. They do, however, invest in fixed-income securities. Returns fluctuate according to the market price of the underlying assets. | Bonds are fixed-income products. Bondholders get monthly interest payments. |
| Liquidity | Debt mutual funds are pretty liquid, and you may withdraw your money at any moment. However, it is critical to examine the exit load costs and tax consequences. | Bonds trade on the secondary market in the same way that stocks do after they are issued. However, the quantities are frequently modest, making them a less liquid alternative. |
| Risk | Mutual funds are very volatile investing possibilities. Although stock market swings have no direct influence on debt funds, interest rate movements do. | The bond issuer is responsible for making monthly interest payments to bondholders. In the event of solvency, bondholders are given priority for repayment. If you keep to maturity, you will not lose any principal. |
| Accessibility | You may effortlessly acquire and sell debt mutual funds. You may get it straight from the AMC or through a distributor. | Bonds are not easily accessible. You may buy bonds over the counter, which makes it challenging for regular investors to invest. |
| Diversification | Funds offer quite a diversified portfolio. | Bonds are primarily single-entity investments. |
| Portfolio management | Debt mutual funds are managed by skilled fund managers who make intelligent decisions to achieve high returns for their clients. | The investor is responsible for selecting, purchasing, and selling the bonds. |
| Expense ratio | The fund charges a fee that reduces returns. | There are some initial costs involved with bonds as well. |
| Tax implications | Varies depending on the holding period (short-term vs. long-term) and amount. | They are typically taxed on interest payments. |
| Fees for early redemption | Some funds charge fees for early redemption. | It depends on terms and conditions. |
| Credit risk | Lower due to diversification across issuers. | There is a higher risk of default by the individual issuer. |
| Interest rate risk | NAV fluctuations due to changing interest rates. | Bond prices can fall if interest rates rise. |
| Minimum investment | Typically, lower minimum investment amount. | It may have a higher minimum investment amount. |
| Investment goals | Regular income, capital preservation, portfolio stability. | Building retirement corpus, portfolio stability |
| Risk tolerance | Suitable for various risk tolerances (depending on fund type). | Lower risk tolerance (G-secs) to higher risk tolerance (corporate bonds). |
Debt Mutual Funds vs Bonds: Which is the Better Investment Choice?
When comparing debt mutual funds and bonds as investment choices, it’s essential to consider your financial goals and risk tolerance. Bonds provide a predictable income stream and are generally considered less volatile. If you are looking for a steady income and are comfortable with a fixed return, bonds could be the better choice for you.
However, if you prefer a more dynamic approach and potential for higher returns, debt mutual funds may be the way to go. Ultimately, it’s essential to carefully assess your individual needs and consult with a financial advisor to make the best decision for your investment portfolio.
FAQs:
- Debt mutual funds vs Bonds: which is better investment option?
Debt mutual funds offer diversification and potentially higher returns, but with some risk. Bonds prioritize safety with predictable returns. Choose based on your risk tolerance - Can I sell bonds before maturity?
Yes, bonds can be sold on the secondary market before maturity. The price will fluctuate based on market interest rates. - What happens if the issuer of a bond defaults?
In case of a default, bondholders may not receive their full promised return. Government bonds are generally considered the safest as the government is unlikely to default.
Got more questions? Want a deeper comparison of Debt Mutual Funds vs Bonds? Refer to our FAQs here to get the answers you need!
Liked what you saw? We’ve got a plethora of such insightful content pieces regarding personal finance, investments, and everything fixed-income under the sun on Aspero’s Fixed Income Academy.
Author Bio:
Sakshi Negi has a thing for numbers and a deep fascination to learn about all things finance. Being a part of the content team at Freo, a neobank that offers flexible and customised financial products, along with benefits such as insurance on balance, safe & secure banking.
