In a surprise move, the Reserve Bank of India (RBI) last week raised the repo rate by 40 basis points (bps) to 4.4%, in response to rising bond yields. Bonds and, by extension, debt funds, have an inverse relationship to interest rates. When interest rates rise, bond prices fall because older bonds become less valuable when rates rise.
As Debt Mutual Fund’ NAVs (net asset value) have been falling for the past few months, online brokerage firm Zerodha explained in a series of tweets as to what mutual fund (MF) investors should do in the current scenario.
“So, the NAVs are falling, what should you do? These funds will recover unless you sell out of panic, which would be a mistake. Short duration funds will recover faster in a few months as compared to long duration funds,” said Zerodha Varsity’s tweet.
Just like equity funds carry risk, so are bond funds. Interest rates move in cycles, and as long as you stick to one full cycle, you’ll be fine. Timing the interest cycle is extremely difficult. The longer you stay invested, the less likely you are to generate negative returns, the brokerage adds.
“For most investors, SIP is one of the best ways to invest in debt funds depending on the duration of their goals, risk appetite and risk appetite. As rates rise, your subsequent investments will be invested at higher interest rates. In the long run, the returns will even out,” it added.
If the investor does not have the capacity to tolerate heavy fluctuations in the interest rate, it is better to invest in short term debt funds, even for long term goals. They can also have a mix of short and long term funds if they understand the risk as there is no one right way to invest.
“Debt funds help you reduce the overall volatility of the portfolio as compared to 100% equity portfolio. Since volatility is low, loans actually help you behave better while investing. This is one less reason to invest in debt funds, which gets lost in all the noise,” the tweet added.
Launched in 2019, zerodha Varsity is a stock learning app that provides in-depth notes on trading, practical tips and insights on capital markets, learning modules on key financial topics.