A common question crops up when you start investing in mutual funds: Should you invest in debt or equity?
You know that equity exposure brings higher returns but also carries a greater risk of loss. Meanwhile, debt funds protect your investment, but they limit your returns potential. This puts you in a dilemma. Is there no middle path?
The mixed exposure has an impact on the returns they bring as well. As an investor in hybrid funds, you are likely to get higher returns than with debt funds. But, the returns may be lower than with equity funds.
(Read more: What is a mutual fund?)
Earlier, investors had only equity-oriented or debt-oriented hybrid funds as options. But there have been changes in the norms governing the categorisation of mutual fund schemes. Today, investors in hybrid funds are spoilt for choice. Take a look at the different hybrid schemes on offer:
Conservative hybrid funds put 75–90% of their assets into debt instruments. The remaining assets may be diverted to equities. These are also known as capital protection funds.
Balanced hybrid funds invest only in equity and debt. Here, 40–60% of a fund’s assets are allocated to debt, equity instruments, depending on the fund’s objectives.
Aggressive hybrid funds focus 65–85% of their investments on equities. They often place the rest in debt instruments.
Dynamic asset allocation funds do not follow any fixed structure. They allocate investments to both equity and debt. They are dynamic in that respect. Such funds are also termed as balanced advantage funds.
Multi-asset allocation funds invest in equity, debt, and one other asset class. In this case, each asset class gets a minimum allocation of 10% of the fund’s total investment.
Arbitrage funds invest at least 65% of their asset pool in equities or equity-related instruments.
Equity savings funds have high equity exposure of 65%. Of this, at least 10% is allocated to debt instruments.
(Read more: Mutual fund terms and concepts?)
Since hybrid funds do not limit themselves to a single asset class, they carry some advantages. Here are a few of them:
The old aged ‘Do not put all your eggs in one basket’ holds true when you invest in the financial markets.
You may invest all your money in equities in the hopes of earning high returns. But when the market turns against you, it could result in big losses. Investments in debt instruments would ensure capital protection, but the returns may not amount to much.
That is why diversification is so important. And that is where hybrid funds can help.
Hybrid funds invest across different asset classes. Thus, they maximise the earnings potential while minimising the risk exposure.
If the market falls and equities suffer, the risk in a hybrid fund would be limited to the part invested in equities. The debt investment would cushion the blow.
If the stock markets pick up, the exposure to equities could end up boosting the investor’s returns by a considerable margin.
Most individual investors have limited financial expertise and market knowledge. They tend to panic when the markets turn volatile. But hybrid funds (like other mutual funds) have professional fund managers to handle investment decisions.
Fund managers have access to the latest in-depth knowledge about markets and companies across sectors. Allocating the fund’s pooled assets is easier for fund managers. This is because they have the expertise and the resources to make informed decisions. Since hybrid funds are already diversified, the investor does not have to worry about maintaining an assortment of funds.
That said, given the new categorisation norms, it becomes easier to switch when the markets turn. For example, an investor who chose a conservative hybrid fund during a bearish phase can easily increase their equity exposure by opting for an aggressive hybrid fund when the market turns bullish.
This gives you a target that you wish to achieve. Knowing your time horizon and the amount you need is important. This will allow you to make the right choice when selecting a hybrid fund.
If your risk tolerance is moderate to high, you could opt for a hybrid fund that has a higher equity exposure. Aggressive hybrid funds or equity savings funds could be good options for you. But, if you are wary of taking too much risk, the more debt-focussed options may work for you.
Experts often tell you to invest through a systematic investment plan (SIP). Taking the SIP route allows you to stagger your investments. In doing so, you can average out your cost of units. A lump sum investment does not offer this advantage and you may run the risk of investing at the wrong time. (Read more: How to start an SIP investment?)
Hybrid funds are suitable for investors who are looking for safety of investment and modest returns. They ensure diversification of your investments. This also protects your money in case of market volatility. And you can choose from a range of options depending on your financial targets and risk appetite.
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