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Debt Funds – Risks – 1

by | Mar 31, 2018 | Finance, Mutual Funds

Generally the pundits say that the portion invested in debt should be your age as a percent of the total invested amount. A 60 year old should have 60% of his total investments in debt – eg. fds, bonds or small savings. I do not agree with such ‘thumb rules’ and am of the opinion that one should have a total of 5 years of expenses invested in debt. This is assuming that the remainder is invested in Equities or Real Estate and the amount invested in debt will be used only when the stock market is down.

The general view is that investment in debt is safe – meaning the value will not go up and down like equities and the investment will earn a fixed and guaranteed return, maybe a bit less than equities.

Now, this is true if one invests in FDs, PPFs (my preferred debt investment), etc or if one buys bonds issued by a company and holds it to maturity – assuming it is a sound company and does not go bankrupt before the maturity of the bonds. If say, one invests Rs.10 lacs in bonds issued by xyz company at say, 9% interest, then one is assured that one will get Rs.90,000 every year till the bonds mature.

When one invests in debt funds, the situation is slightly different. You are allowed to withdraw the money whenever you want. The fund manager has to keep some amount in cash in anticipation of such redemptions – this reduces the returns. The problem for the fund manager is when the redemptions go above the cash reserve maintained by him. In that case, he has to redeem the bonds prematurely. This makes the situation interesting. In investing, every time things become interesting, generally the risks go up!



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Written By: niranjan

Financially Stupid Niranjan


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