Why Is Debt Allocation Important For Your Portfolio?

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  • 28 Jan 2023
Why Is Debt Allocation Important For Your Portfolio?

Many people liken investing to gambling, where you can lose it all, but this is not true. It would help not hedge your bets on a single option or asset class when investing. So, when you aim for wealth generation with equities, don’t forget to add stability to your portfolios with debt.

Why Is Debt Allocation Important For Your Portfolio?

  • Stability:

Equity investments can deliver wealth but are subject to significant volatility linked to the stock market. Debt funds invest in fixed-income instruments, so they are not affected by market fluctuations like equity funds. They remain stable even when markets fall.

  • Low risk:

Debt mutual funds invest in government bonds, treasury bills, and other money market instruments. Other debt instruments are bonds, fixed deposits, corporate deposits, Public Provident Fund, and more. The nature of the investment offers safety to the investor. Together, the safety and the stability of the debt asset class help cushion an investment portfolio against unfavourable market reactions.

  • Liquidity:

With debt mutual funds, you can withdraw the amount you require while keeping the remaining amount invested. They have no lock-in. Moreover, they have varying timeframes, ranging from 91 days to three to five years, so that you can invest as per your time horizon.

  • Income:

Since debt funds invest in fixed-income instruments, they offer the safety of your principal investment and a stable interest income. In a way, they are similar to fixed deposits (FDs) but with comparatively better returns and taxation benefits. The income generated by debt funds may be offered at varying intervals, depending on the fund and policy.

How to allocate debt in your investment portfolio?

Asset allocation is a crucial aspect of a successful investment strategy. It aims to balance growth and safety as per your financial goals and risk appetite. If your investment portfolio is heavily skewed toward equity investment, you will need to add a proportion of debt investment.

Experts suggest that debt should be added, considering your age. So, subtract your age from 100; if your age is 30, 70% of your portfolio should be in equity, while the remaining 30% should be in debt. As you grow older, the percentage of the debt will also increase, thereby providing more stability to your portfolio as your retirement years approach. This means that asset allocation or portfolio rebalancing should be a crucial and ongoing feature of your financial planning. You can also add debt by investing in a hybrid fund that allocates a portion of its corpus in equity and another in debt, depending on market conditions.

The Takeaway

Debt funds are relatively stable and limit your exposure to market risk, acting as a cushion for your portfolio. Select your debt investment carefully, keeping your financial goals and investment horizon in mind.

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