In a surprise move, the Reserve Bank of India (RBI) last week hiked the repo rate by 40 basis points (bps) to 4.4%, with bond yields rising in response. Bonds and, by extension, debt funds have an inverse relationship with interest rates. When interest rates rise, bond prices fall as when rates rise, older bonds become less valuable.
As debt mutual funds’ NAVs (net asset value) are falling since the last 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, NAVs are falling, what should you do? These funds will recover unless you sell in panic, which would be the wrong thing to do. The short duration fund will recover faster over a few months compared to the longer duration funds,” Zerodha Varsity’s tweet stated.
Just like equity funds have risks, so do bond funds. Interest rates move in cycles, and as long you stick through an entire cycle, you’ll be ok. Timing interest cycles is extremely hard. The longer you stay invested, the lower the odds of you making negative returns, the brokerage further explained.
“For most investors, SIPs in debt funds based on the duration of their goals, risk appetite and risk capacity is one of the best ways to invest. As rates rise, your subsequent investments will be invested at higher interest rates. Over the long horizon, returns will even out,” it added.
If the investor does not have the ability to bear severe interest rate volatility, it’s better to invest in short term debt funds, even for long term goals. They could also have a mix of short and long duration funds if they understand the risk as there is no one right way to invest.
“Debt funds help you lower the overall volatility of a portfolio compared to a 100% equity portfolio. Since the volatility is lesser, debt actually helps you behave better when investing. This is an underrated reason for investing in debt funds, that gets lost in all the noise,” the tweet added.
Launched in 2019, Zerodha Varsity is a stock learning app which offers in-depth notes on trading, practical tips and insights on the capital markets, learning modules on key financial topics.