When it comes to investing in mutual funds, the playing field is huge. Today investors have access to various different kinds of mutual funds. While options are great, and having a variety of funds to choose from is of course better than not having enough choices, it is very important to really understand what each different kind of investment entails.
Some types of mutual funds are intrinsically more risky than others. If you are a new investor, you might think that investing in a low risk mutual fund category such as a Debt Mutual Fund is automatically a good idea.
While a Debt Mutual Fund is relatively safer than some other kinds of mutual funds, it is important to really understand what it means to invest in one. Read on to find out.
There are five different types of debt instruments that are most frequently used to build a debt fund.
1. Treasury Bill — Here, investors lend money to the central bank. In India’s case, investors would be lending to the RBI, when their money is allocated to Treasury Bills.
2. Certificate of Deposits — A Certificate of Deposits is essentially a promissory note that is issued by a bank. Allocating money to a Certificate of Deposits is very similar to putting money in Fixed Deposits. However, unlike Fixed Deposits, a Certificate of Deposits is transferable between two people.
3. Commercial Paper — A Commercial Paper is a debt instrument designed for short term borrowings of less than 12 months. Commercial Papers are issued in the form of promissory notes by corporates.
4. Debentures — Debentures are long-term debt instruments, which are issued by both, corporates and the government. The borrower does not offer up a collateral in exchange for the loan. Investors rely on the borrower’s integrity when investing in debentures.
5. Bonds — Similar to debentures, Bonds are essentially loans given to large corporates and the government, for very long durations, such as ten years or more.
About 80% to 90% of most Debt Mutual Funds comprise of the above mentioned five debt instruments as their holdings.
Debt instruments pay out a periodic interest, thereby generating fixed returns for investors. Even though investing in debt instruments is relatively safe, there are some inherent risks involved.
· Credit Risk: If you lend your money to a corporate, and the corporate either defaults on the date of repayment of money, or fails to repay your money entirely, it is known as credit risk.
· Interest Rate Risk: After you buy a bond, market interest rates can fluctuate and go up or down. This will in turn change the price of the bond you have purchased. This inherent risk involved in purchasing bonds is known as interest rate risk.
The Tarrakki App guides to you invest in the right kind of mutual funds based on your income group, age bracket, financial goals, and risk profile.
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