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Debt vs hybrid funds

Q. I want to invest my money in mutual funds, but am confused between debt and hybrid options. I want to invest ₹5 lakh for 5 years. Where can I invest? Should it be in debt or hybrid mutual funds?

A. Debt funds invest purely in debt instruments — government bonds, corporate bonds, treasury money and short-term certificates of deposits and commercial papers. There are different categories of debt funds to suit different investment time frames and risk profiles. Overnight funds are the least risky and most liquid and are meant for short-term parking of money. Credit risk funds, on the other hand, carry far higher risks and are suitable only for 3-year time frames and above. Hybrid mutual funds carry either an equity or a debt tilt or use derivatives to hedge the risks in equity. A hybrid fund with around 65% in equity and rest in debt is called an aggressive hybrid debt (equity-oriented fund) while a fund with about 25% in equity and rest in debt is called a conservative hybrid fund (debt-oriented).

Then there are equity savings and balanced advantage funds that have an equity tilt but hedge part of their equity with derivatives. There are also multi-asset allocation funds that invest in equity, debt and gold. Hybrid options are typically used when an investor wants to invest in an asset allocated manner but also has limited money to spread them in multiple funds. In the hybrid category, conservative hybrid options carry relatively lower risk and require a lower time frame (minimum of 2-3 years recommended).

Equity savings, balanced advantage and multi asset categories come in the middle in the risk matrix while aggressive hybrid funds carry high risks. Still, the aggressive hybrid category is considered less volatile than pure equity funds, given their debt allocation.

Now, coming to your question, we do not know your age or risk profile or purpose of investing. However, for your time frame and amount mentioned, you can consider a mix of multi-cap, midcap equity funds with 60-70% allocation to equity. Using equity funds instead of equity hybrid will help you mix different investment styles and strategies in equity. In debt too, you can use a combination of low risk and medium risk options and allocate 30-40% in short duration and corporate bond debt funds. Use the growth option in all schemes; for the equity portion, do a systematic transfer plan over the next 10 months.

Liquid funds

Q. What is the use of liquid funds in my portfolio? Are they substitutes for my savings account?

A. Liquid funds, as the name suggests, provide you liquidity as you can take out the money any time without any charges. Please note that liquid funds are low risk but not risk free. So, they are not exact substitutes for Savings Bank account (SB account). These funds invest in short-term certificates of deposits, commercial papers and short-term bonds. The residual maturity of the papers needs to be less than 90 days. The returns are linked to the interest of the underlying instruments and is not fixed like the SB account. Returns accrue every single day on all 7 days of the week and accumulate on the NAV. Capital gains on sale are taxed like all debt funds.

Liquid funds can be used for multiple purposes. One, these funds can be used to park excess money in your savings bank account as they seek to deliver slightly higher returns than your SB account. Some liquid funds have ATM card facility that allows you to withdraw part of the money instantly. Two, liquid funds can be used to temporarily park large sums you get either from sale of assets or from any other settlement of money. Finally, liquid funds can be used to systematically transfer money to equity funds to avoid risk of timing the equity market. It is also a good idea to park some money in liquid funds and deploy in equity funds when markets fall and provide averaging opportunities. You can also sweep periodic profits from equity into liquid funds.