Invest your money in debt mutual funds now

So you thought debt mutual funds were safe ? One always gets to hear about bloodbath in the stock market when the Sensex tanks. Investors lose their shirts in seconds, rarely do you hear about losing money in debt funds.  This changed on July 16th.

Banking System

The Reserve Bank of India (RBI) decided to suck money out of the banking system.’ This is to cushion the fall of the rupee. It used some tools as its end for the purpose.

Firstly it forced the banks to borrow less. It can do that by using a policy tool called LAF – Liquidity Adjustment Facility. The LAF is essentially used by banks to meet their day to day liquidity requirements. So if the banks are forced to use less money, they will go elsewhere to pull it out from. More on that in a bit.

Secondly, as if this wasn’t enough, the rate at which the banks could borrow under this restricted scenario was hiked as well. Quantitatively, this was hiked from 8.25% to 10.25%.

Debt Mutual Funds

What this meant is that banks found it impossible to borrow money from the RBI and began to dump off their debt holdings to meet their short term liquidity requirements. This led to a huge supply of these instruments in the market and their prices fell – in perfect relation to the supply demand scenario of anything on this planet. When prices fell, the yields went up – remember they are inversely proportional.

When interest rates rise, mutual funds schemes which are invested in long term maturity instruments get hit the most. So long term bonds were hit the most as were G-Secs, some as large as 4% in a single day !

The returns of the various categories of mutual funds in the debt space as ON July 16th stands as below – data if from ValueResearchOnline.com

Bond prices don’t crash too often – I am not aware of when they happened last but from what grapevine has it, laid back investors who don’t bathe over the weekends also took notice of this event. After all, debt mutual funds do not lose between 2% to 4% too often. Depending on where your debt mutual funds invests in, you might have suffered losses as well. So the question is – “What do you do Jack, what do you do ?”

Debt Mutual Funds – What should do you now ?

As is always the case, if you lost money in stocks. Or your car got stolen or you girlfriend dumped you, don’t set alarm bells ringing for yourself and the world. Stay put – breathe in and out. Rinse, repeat and think.

Ok, I know it’s not helping but let’s look at it this way. The reason you parked money into debt mutual funds was because you were looking at goal based investing. You wanted money in the short term. For eg say 1 month or 5 years (if I may define short term as 5 years before some of you readers take me to the cleaners for assuming that).

Now you would ideally park your emergency fund in liquid mutual funds – and they were the least affected – I did say breathe out ! It’s a matter of days and weeks before you recoup your losses. Don’t pull the money out yet – this gyaan is the same which financial advisors pitch when your investments in equity tanks. You make money buying low and selling high, why would you sell now when your investments are already low. By all means, if you need the money then you need the money. Then you need to sell with a loss to make use of it but to best of your abilities, try and refrain from cashing out now.

Short and Long Term Instruments

If you have parked your money in short term and long term instruments, then wait it out. Remember that this cycle will reverse and we cannot for sure know when. So it is only wise to remain invested in line with your overall asset allocation. If you have invested in long term bonds, your pain is here to stay but don’t sell and run yet – align the investment to your goal and wait patiently while you take cue from your financial advisor.

If you are in need of taking an exposure to the debt mutual fund space, now is the time but expect some volatility of course. You can put your money in but as said earlier, align it towards a future financial goal. You might have – don’t invest because things have gone down. In that way all the stale vegetables of the market should have been in your kitchen !

Here is a beautiful article on what to do with debt funds now from FundsIndia. A rather technical explanation is from OneMint here.

Whatever you do, expect some volatility and churn in the debt mutual funds space. After all, it’s been very long that the equity stock markets were taking away all the bad news !