Debt vs Hybrid Mutual Funds: what are they and which one should you invest in?
Investing in mutual funds is a way of growing money over time. The returns are much higher than what financial institutions can provide since they use “power of compounding” and you can see money growing marginally, over time. With apps and tech enablements being released frequently – investing in mutual funds have become a much easier task – now, it’s on our smartphones too!
It’s universally agreed that the longer you stay invested in mutual funds, the better will be your returns. And an informed mutual fund investor, with a view to making good money on their investments, usually doesn’t look for short term gains and benefits and invests for long term.
photo/ Gerd Altmann
What does a long term investment look like?
It could range anywhere between 5+ years to even 20 years. Don’t frown just yet! Because if you want to gain handsome returns on your investments, that’s the kind of investment horizon you need to be looking at.
But a frequent question that comes up while talking about investing is which funds?
Now, while the more important job is to start investing, it’s good if you also know the best funds where to invest in. Which is why it is important to understand the different kinds of funds. There are over 10 kinds of mutual funds you can invest in, depending on the kind of growth you want, the industries you want to invest in and what’s your objective.
In the light of this, let’s have a look at two of the most coveted categories of funds and know about the various ways they differ and what kind of investors prefer each one.
Hybrid Funds
Hybrid Mutual funds, just going by the title, invests in both equity and debt funds. They are therefore safer to invest in and are a favourite for conservative investors. Here, the debt part of the fund provides safety against market turbulence, making it a dependable choice, especially when the markets are down.
For a smart investor, the split of the equity to debt ratio is a must-know.
In India, hybrid schemes are mandated to invest 65-80% in equity and the rest in debt. Stability in mutual funds come from the debt component and along with the equity component, which promises good returns, for a new investor, this healthy mix of the two leads to a comfortable investment vehicle.
Within hybrid funds, there are many different types of funds which differ on the basis of asset allocation.
Some of the examples include, Conservative Hybrid Mutual Funds which put 75-90% of assets in debt instruments. Balanced hybrid ones invest in equity and debt with 40-60% in favour of debt. And aggressive funds have an inclination towards equity, with 65-85% in favour of it.
Some of the advantages of investing in a hybrid fund are, firstly, they provide a diversified portfolio as they are safe plus provide a high returns potential. As a result, if the market crashes, the debt investment would even out the equity; if the markets did well, then the equity aspect could marginally increase returns.
Finally, in regards to taxation, hybrid funds with more than 65% equity allocation are taxed as equity funds and those with less than 65% equity as debt funds.
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Debt funds
Debt mutual funds are those that invest in items such as debt securities, money market instruments, treasury bills, corporate bonds, etc. These funds are for investors who are conservative and don’t want equity in their portfolio – in other words, are completely risk averse. They are the kinds who chase high returns by selecting funds with a high Yield to Maturity.
On a scale of funds, they are less risky compared to equity funds but are riskier than hybrid funds.
An investor in a debt fund is a short to medium-term investor. The time span of investment being between overnight to months till 10+years. Because of the breadth of time of investment – there are currently over 10 categories of debt funds, each for a particular intended use case.
The shortest duration debt fund is an overnight one, the longest, a gild fund.
With a debt fund, it is important to know where your fund manager has invested – usually, they do it by credit rating. A higher credit rating translates into a higher chance of regular interest.
There are several aspects an investor should be aware of other than the credit rating aspect. For example, the first and most important, market situation since debt funds are linked to interest rates. Secondly, exit load and expense ratio – know the cost of pulling out your money from a debt fund. While most investors in debt funds do stay long term, if the market is not supportive, they do need to pull out money which would cost.
To conclude, after evaluating the differences and risk propensities, I we think you should be at an advanced position to decide which one should be your investment vehicle. Your choice should always be aligned to your risk appetite, your goals and the time horizon.
