“My journey in the world of mutual fund investing is marked with phases where I had to teach myself new things and unlearn a lot of preconceived notions about mutual fund investments. And that is how I came to know the importance of having debt funds in your portfolio,” narrates Atharv Sinha (name changed), a software professional.

Retail investors new to the world of mutual fund investments often harbor the notion that mutual fund investments are all about equity investments. However, that perception is flawed because debt funds play an equally important role and are a must-have in your portfolio. If you are wondering as to why that is the case, it is because equity investments carry high risks and when the market start entering the red territory, based on your asset allocation, debt funds can ensure that you have some degree of immunity from market corrections.

Stock market corrections are a necessary evil. It is defined as a fall of 10 percent or more in the prices of stocks from their most recent highs. Anticipating a correction is futile exercise and trying to enter or exit from investments during periods of correction can be risky business unless you can make entries as well as exits at the right time. Yes, some people have been lucky and have been able to make some money in the short term by tapping into these phases. The chances of that happening consistently in the long term are negligible.

It is common knowledge that equities can be most impacted by market corrections. In order to minimize exposure to wild market fluctuations, selecting a mix of investments that have less potential of their values falling sharply during corrections is highly recommended. Debt funds fit the bill perfectly for this purpose – during market corrections when equities are not performing well, your debt fund investments will act as cushion against the fall.

Growth and wealth creation are agreeably the most important portfolio objectives but that may not be enough. It is imperative for investors to inject stability in their portfolio and that is where debt funds come in. Yes, in the long run dent funds may not generate returns to the tune of equities but they definitely add that much needed element of predictability and stability in your portfolio because debt funds are largely impacted by interest rate changes and not stock market corrections. Also, given the flexibility and liquidity afforded by debt mutual funds, these are a great option for securing your short-term goals than relying on equity exposure.

What’s more if you are looking at ensuring a steady stream of income from your investments, debt mutual funds are a better bet than equities in this regard. Yes, equities pay dividends but there is no guarantee. With debt funds, irrespective of whether you choose the growth or dividend option, you do not have to worry about regular income. While your tax liabilities may pan out differently in each case, but the crux remains that getting regular income is easy with debt funds. This can be very useful during market corrections if you urgently need financial resources but other asset classes are affected by the corrections and exiting from them for meeting liquidity requirements can lead to losses.

Many investors make the mistake of simply adding debt funds but they fail to shift allocations on a regular basis. Sinha narrates, “I made the same mistake thinking that since I had invested in debt funds, I needn’t worry but it took me a while before I realized that my debt fund allocation was insufficient and I needed to increase it to avoid losses disproportionately higher than what I could bear. It is important to have an asset allocation strategy to make the most of debt funds especially for periods during which prices of equities are expected to suffer.”

Asset rebalancing needs to be conducted periodically and despite being an essential mantra in the field of mutual fund investing, it tends to get pushed to the backburner. Asset balancing helps you adhere to a target equity-to-debt ratio in your portfolio and periodically adjusting it to ensure that the appropriate ratio is maintained. This allocation formula between equity and debt largely depends on your investment horizon and your risk-taking abilities.

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Mutual Fund investments are subject to market risks, read all scheme related documents carefully.