Mutual funds are one the best options to park your money as it is the area of investment which covers all the areas of the funds. There are many options in mutual funds such as equity or debt or any of the other debt equity funds. The various classes of the investors do invest in the different funds as the risk factors affect the equity and debt funds differently.
The aggressive investors who are ready to take high risks will prefer the equity funds as they give more returns comparatively, and those who are conservative in nature will prefer the investment in debt as they give a low return but the regular income can be received. Here is what Reinvestment Risk can do to your Debt Mutual Funds by FinanceShed.
Debt Mutual Funds And Risks Associated With It
Debt mutual funds are the funds that are invested in the mix of debt or fixed income-generating bonds and bills such as government securities, corporate bonds, treasury bills, etc. so it is the investment in the different debts in the different time period.
For some years people used to think that there is no risk in the debt funds as they invest in a secure way as well as in the fixed income bearing investments but there are some of the inherent risks in the debt mutual funds and also there are some of the risks which cannot be removed from the investments.
Risks which are the threat for the investors willing to invest in the debt mutual funds are Risk of reinvestment, Inflation, Global/domestic factors, Rating of papers, Managing risk. There are many more risks that people do not see and understand as they think debt funds are safe, here we will discuss how the reinvestment risk will affect the returns generated on your debt funds.
Reinvestment Risk And Its Effects
Reinvestment risk means the risk of fluctuating interest rates on different bills and bonds. Many a time it happens that you have prepared a portfolio so that you can achieve the targets of the investment you need to make to reach at a particular saving amount after some years. When the investment is done in the debt we assume that we can reinvest the amount received from the funds, but if the interest rates go lower with the time it will not be possible to yield the interest as planned by the investor thus the returns on the reinvested amount will be lower than the expected one.
So when the yield to maturity ratio comes lower it will not be possible to receive interest as desired and also the reinvestment chain will be of a lower amount than the decided one. If an investor invests 10000 in debt funds with the interest rate of 6% then he will be able to receive the interest of 600 every year and when the interest and principal are reinvested the interest rate falls down to 4% so the amount of return on the reinvested fund will be very low.
It is seen that due to the reinvestment risk the investor losses his principal amount also. And if the objective of the investor is to earn a regular income then also the lower interest rate will affect the regular returns.