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Investing in the financial market can potentially help you build wealth over time. However, the risks involved can make investors wary.
This is where diversification comes in. A balanced portfolio with both debt and equity mutual funds can help you manage risk and while also tapping into the potential to build wealth over time.
This article explains what debt and equity funds are and how to combine them in your portfolio.
Understanding debt and equity funds
Before investing, it is important to understand what debt and equity funds are:
- Debt funds invest in fixed-income securities like government bonds, corporate bonds, treasury bills etc.. They are considered less volatile compared to equity funds. They offer relative stability, but their return potential is modest and may not outpace inflation in the long-term. This makes them comparatively more suitable for short or medium-term goals. Conservative investors can also select debt funds with a longer portfolio duration for long horizons.
- Equity funds invest in shares of companies and offer the potential to build wealth over time. However, they require a high risk tolerance as markets can be unpredictable and volatile, especially in the short term. A long investment horizon is usually recommended for such funds. This helps potentially ride out market cycles.
The key advantage of mutual funds is that you can easily invest in more than one scheme. Instead of having to independently create and manage a diversified portfolio, you can choose a few schemes and achieve the same diversification. This allows you to combine both debt and equity funds in your portfolio, so that you can balance risk and reward potential and work towards both short and long-term goals.
How to invest in debt funds
Investing in debt funds requires careful selection based on your investment horizon and risk appetite. Here are the steps to invest in debt funds:
1. Assess your investment goal: Decide whether you want to invest for short-term, medium-term, or long-term needs.
2. Choose the suitable type of debt fund: Options include liquid funds for short-term needs, corporate bond funds for medium-term investments, and long-duration funds for longer term investments.
3. Check expense ratios: Lower expense ratios can help optimise net potential returns.
4. Choose between lumpsum and SIP: A Systematic Investment Plan (SIP) can help invest in affordable instalments. A one-time lumpsum may offer better return potential in debt funds as the entire capital gets market exposure from the start and market timing risk is low when compared to equities.
How to invest in equity funds
Investing in equity funds requires a long-term approach to manage market ups and downs. Here are the key steps:
1. Define your risk tolerance: If you can take higher risks, you can allocate a larger portion to equity funds.
2. Select the suitable category: Large cap funds are relatively stable with relatively steady long-term growth potential. Mid cap and small cap funds may offer better growth potential, especially in bull markets, but have higher risk and can be significantly impacted by volatility. Flexi and multi cap funds combine large cap, mid cap and small cap funds for broader diversification and a more optimal balance between risk and return potential.
3. Diversify across sectors: Investing in different sectors can help reduce risk.
4. Use SIP for disciplined investing: SIP allows you to invest a fixed amount regularly, reducing the impact of market volatility. SIPs can be suitable for equities as they allow you to potentially build wealth over time through regular investments and reduce market timing risk.
Monitor your investments: Review your portfolio periodically and make adjustments if needed.
How to create a balanced portfolio
A balanced portfolio combines both debt and equity funds to optimise potential returns while managing risk. Here’s how you can do it:
- Determine your asset allocation: A common rule is to allocate a percentage to equity funds based on your age. For example, if you are 30 years old, you may allocate 70% to equity funds and 30% to debt funds. However, your risk appetite and current budget are also important considerations.
- Adjust based on market conditions: If equity markets are highly volatile, you can shift a small portion to debt funds for relative stability. However, it is important not to overreach to short-term volatility.
- Rebalance regularly: Review your portfolio every 6–12 months and rebalance if one asset class grows significantly compared to the other.
Conclusion
Investing in both debt and equity funds can help you build a balanced portfolio. The key is to choose the suitable funds based on your financial goals, risk tolerance, and time horizon. Remember to review your portfolio regularly and make adjustments when needed to stay on track with your investment journey. Consulting a financial advisor is recommended, especially for major investment decisions.
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
