Investing in a debt portfolio is a good way to build a relatively risk-free portfolio that can help you grow your investment over the years. But investing the right way in the best mutual funds is necessary. Read on to find out how to build a stable debt fund portfolio. Below are the essential steps to follow.
Choose the right debt fund categories
There are many types of debt funds to choose from based on your risk appetite and investment needs. The main categories are liquid funds, ultra-short duration funds, short duration funds, medium duration funds, long duration funds, and gilt funds. Liquid and ultra-short duration funds are good for parking your emergency funds as they invest in very short-term bonds. Short and medium duration funds invest in bonds with 3–5-year maturities, so they have moderate interest rate risk but higher returns potential. Long duration and gilt funds invest in longer maturity government and corporate bonds, so they tend to be riskier but have the potential for higher returns.
Decide on your investment goals
Your investment goals will drive what type of debt funds you choose. If capital preservation is key, focus on liquid and ultra-short-term funds. If you want stable returns to beat inflation, short and medium-term funds are good options. For long-term wealth creation, you can consider long duration and corporate bond funds. Gilt funds primarily invest in government securities, so they provide stability but returns depend on interest rate movements. Define your goals so you can align them to the right fund types.
Consider your risk tolerance
Debt funds come with interest rate risk, credit risk, and liquidity risk. Interest rate risk is higher for long duration funds, as bond prices fall when rates rise. Credit risk is higher in corporate bond funds, as companies can default on payments. Liquidity risk is lower for short-term funds as the bonds are very liquid. Make sure you understand the risks and only invest in debt funds that match your risk tolerance. Conservative investors can stick to government securities funds and short-term funds, while aggressive investors open to more risk can consider corporate bond and long duration funds.
Diversify across issuers and maturities
Choose debt funds that invest across companies, sectors, ratings and maturities. This provides diversification and reduces risk. Only invest in some of the best mutual funds where no single company or bond comprises more than 10% of the portfolio. Look for a mix of AAA, AA and A-rated bonds, and choose funds with a range of maturities from 1-10 years. A diversified debt fund will limit concentration risk and provide more stable returns over the long run.
Review and rebalance periodically
Once you build your debt fund portfolio, monitor it regularly. Review the performance of each fund quarterly and compare to the fund’s benchmark and peer group. Check if the fund’s strategy or positioning has changed. Rebalance by exiting funds that are consistently underperforming or no longer meet your needs. You can also rebalance to maintain your target allocations across different fund categories. Regular rebalancing helps ensure your debt fund portfolio stays on track to achieve your investment goals.
Conclusion
Apart from the above points, it is important to invest for a longer time period as well. While debt funds are low risk relative to equity, your principal can still fluctuate with changing interest rates. So invest with a time horizon that allows for any interest rate cycles to play out so you can get optimal returns.
