Investment strategies for Bond Funds & Liquid funds
Don’t invest more than 30% in low risk products like bond funds and liquid funds, why?
A bond fund is a type of fund that invests in bonds or other debt securities typically paying periodic dividends that includes interest payments. It is mostly contrasted with stock funds and money funds.
Liquid funds are a type of mutual funds that invest in money market, instruments like certificate of deposit,securities, treasury bills etc.
Low risks funds like bond funds and liquid funds can be a great means of generating income and widely considered to be safe especially compared with stocks but this is not entirely true as there are some potential pitfalls and risks to holding funds.
Some of the underlying risks are discussed below:
- Interest rate to prices: in the case of bond funds, the interest rate and the bond prices has an inverse relationship i.e. any increase in the interest rate will automatically result to decrease in bond prices, conversely when the interest rate declines, the prices of the bond funds increases. This is because the investors try to capture the highest interest rate when the interest declines and they hold onto the bond fund, consequently this result high demand leading to the increase in bond prices.
- Liquidity risk: there is high risk that an investor might not be able to sell his or her corporate bonds in the case of bond funds due to a thin market especially with corporate bonds. Liquid funds on the other hand might be as liquid as it sounds, most times you don’t have the access to cash like savings account. In the case of emergency, if you request for the redemption of the fund, you might have to for a duration of T+1 day to get it. In such situations, your emergencies won’t be met.
- Reinvestment risk: this is another danger that is faced mostly by bond funds investors, bond funds investors have to reinvest their funds even at rates lower than funds were earning. The risk is higher when the interest rates fall over time and investors have to reinvest automatically.
- Risk with callable bonds: the callable feature of bond funds allows for the issuer to redeem bond prior to maturity leaving the bondholder with the principal payment. Investors are then left cash which they might not be able to reinvest at a rate comparable to initial fund.
There are underlying factors affecting low risk funds are most times not clearly understood by most investors. Before investing, it is better to go deep and understand the underlying factors affecting the fund you want to invest in. Liquid funds can fall as low as 7% in a single day due to not understanding or monitoring the fund portfolio.
The most important thing is to learn about the fund’s manager risk ability and the quality of the paper. Most people ignore this steps before investing in funds and simply believe that “low risks funds are low risk funds.”