Mutual funds are a common investment option. However, there are risks involved while investing in mutual funds. Credit risk is one of the most basic risks that are present by default and are related to repaying the principal and the interest amount.
Credit risk mutual funds, also known as credit risk debt funds, invest in securities with lower ratings. Since the instruments have low ratings, the risk is high. These funds are popular because they provide a high interest rate due to their low-quality nature.
But the main question is: Are credit-risk mutual funds safe? We will answer this question in the article and also discuss whether you should invest in these funds.
Is It Safe to Invest in Credit Risk Funds?
Compared with other types of debt funds, these funds are relatively less safe since they work on the probability that the credit ratings of the securities invested might get better. Since this is only an expectation, it is always possible that the low-credit securities might be further downgraded, affecting the fund’s performance. Additionally, there are more liquidity risks involved in the fund as well.
However, while there is risk involved, these funds also provide a tax benefit since they are debt funds. Your long-term gains will be taxed at 20% after indexation.
As a result, while the fund can provide a high rate of returns, there is also a comparatively high risk involved in it. This means that only investors with a medium to high-risk tolerance must invest in these funds.
Factors to Consider Before Investing in Credit Risk Funds
Since these funds are relatively high-risk, here are some factors to keep in mind while investing in the best debt mutual funds:
- Choose a credit risk fund that is diversified across different securities to minimize the risk.
- Verify the fund’s expense ratio before investing in it. Since the expense ratio is the expenses incurred for investing, it will affect your final funding from a fund.
- Consider investing in credit-risk mutual funds that have a larger AUM. This helps significantly reduce the risk associated with these investments.
- Invest only a percentage of your portfolio in these funds since the risk associated with them is comparatively high.
- Evaluate the past performance of the fund manager and the fund to assess whether the investment is a good option.
If you consider all these factors, you can make your investments relatively safe and earn good returns on them.
Conclusion
Credit risk funds come with a risk pertaining to the principal amount as well as the interest. However, since these funds are low and of low quality in nature, they might sometimes give excellent returns.
As a result, investing in these funds is risky compared with other mutual funds, but the returns involved make it worth it. Therefore, if you have a good risk tolerance, considering the credit risk funds can be a good investment opportunity.
Happy Investing!