Investors usually give much importance to the safety of investment, so they typically select safer short duration funds for investment. But as they say with more risk comes more return, so there is another category of debt mutual funds called a Long Term Debt fund that has more risk but provides higher returns than the bank fixed deposit. This article will provide you with information through which you can analyze these Long Term funds and select the best fund suitable for you.
What are Long Term debt funds?
Long Term debt funds are those funds that lend money to the corporate and government by buying corporate bonds and government bonds. The debt funds which have a period of more than three years are considered as Long Term. These funds are quite risky and suitable for investors looking for an investment horizon of more than three years. These funds are sensitive to interest rate changes and can be more volatile compared to other debt categories.
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Things to be considered before choosing a scheme
- Fund Objectives – Mutual funds try to diversify the portfolio to increase profits and reduce risk. So an investor should see if his and the fund’s objectives are in line with each other or not.
- Risks – There are three types of risks –
- Credit risk – an investor can look at the credit ratings given by credit rating agencies. In credit risk, the fund manager may invest in low-credit rated securities which have a higher probability of default.
- Liquidity risk – It occurs when the fund manager cannot sell the underlying assets; an investor should look at the net assets or assets under management.
- Interest Rate risk – It occurs when the interest rate fluctuates. In interest rate risk, the bond prices may fall due to an increase in the interest rates.
- Costs – There are three types of expenses associated with mutual funds –
- Entry Load – The fund charges this cost at the time of investing in the mutual fund. However, it is rarely seen that a fund is charging an entry load fee.
- Expense Ratio – This ratio shows how much money an investor has to pay to the fund for managing his money.
- Exit Load- If an investor decides to withdraw money before the maturity period ends, a fee is charged for it called the exit load.
- Minimum Investment – Every fund asks the investor to invest a minimum amount, at least in the fund. The investor should see if he could afford such an amount or not.
- Investment Horizon – There is a different maturity period for every mutual fund scheme; an investor should choose the scheme which matches his investment horizon.
- Financial Goals – Different investors have different goals, so before selecting a mutual fund, see if it matches your goals. Some investors want a regular income from the investment, so they should invest in those funds that provide dividends.
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How to evaluate a fund?
- Fund Returns – Look at the returns of the fund from the past 1 Year to 10 Years. Choose from the funds which have been outperforming the benchmark and peer funds.
- Fund History – Choose from the funds which have been providing consistent returns for at least the last 5 to 10 years.
- Costs – Select from the funds you can afford to look at the different expenses mentioned above and see if you can afford it.
- Financial Ratios – Use financial ratios such as standard deviation, Sharpe Ratio, Alpha, and Beta to analyze a fund. High standard deviation and beta show the fund has high risk. A high Sharpe Ratio shows that you can earn higher returns with every additional unit of risk taken.
Best Performing Long Term Debt Funds in 2020
Before selecting a fund, an investor should analyze the fund from various perspectives, using the qualitative and quantitative parameters mentioned above. Just keep your risk appetite, financial goals, and investment horizon in mind while making the decision. Also, keep assessing your investment from time to time and add and withdraw money according to the changes in the market conditions.