Before taking any Debt Fund position you should think about, why I want to buy a bond fund in the first place?
· Are you saving for your retirement? Then you might want to consider long term bond funds.
· Are you moving out of FD to attain higher yield offered by bond fund? Short term bond fund may be the best choice
These questions will help you determine the Quality & Maturity characteristics that you want to invest in.
1) Quality – Investors can get higher returns as they move down the credit rating of bonds. So you should consider the average quality of bond’s portfolio and its distribution across security as well. BBB is the lowest investment grade rating. Since each drop in quality entails an increase in yield, gaining extra yields is easy at the cost of higher credit risk.
There is no point in purchasing a lower-quality bond fund that incurs a higher expense ratio than a higher quality bond fund with comparable maturity.
2) Maturity – Average maturity is a two street. You can gain higher yields by investing in long term bonds but because of changing interest rate environment it can be as volatile as stock investments (aka Capital risk).
If you focus more on short term bonds, then you will not get higher yields. (aka Income risk).
Therefore, it is important to select a fund based on your desired maturity to balance income risk and capital risk.
3) Cost of Ownership – While some stock funds have provided premium performance despite prodigious cost, most bond funds, most of the time, have failed to do so. The reason is that, within the major sectors, bond funds operate under comparable quality and average maturity standards. So, make sure expense ratios are not high.
4) Tax Implications – Consider you post tax returns. If you hold Bond fund for less than 36 months, it’s taxed as per your tax slab rates. For periods more than 36 months, it’s taxed at 20% rate with indexation benefit.
5) Fund’s investment objectives & policies (Quality & Maturity standards) – Fund’s investment objective will give you idea on the quality & maturity of bonds in fund’s portfolio, if should match with your investment objective.
For more details, you can also refer to our detailed study on Mutual Fund Analysis.
A financial advisor can help you determine the right products based on your investment objective. Feel free to schedule a call with us Consult Us, we will help you create an investment plan best suited for your goals and investment objectives.