Investors are always looking for ways to invest their money so that they can get the maximum possible returns. Where new investors or those that are not very experienced will look for more risk-free and stable options like a diversified mutual fund, seasoned and long-time investors are willing to take a little risk if it means that their returns will be about 2-3% more. Now there are many investment options that require some risk but can give returns that are more than normal. One such area of investment is the credit risk fund. Read on to find out more about credit risk funds and how they can be used for better returns.
When you invest in mutual funds, you are given the option of dividing your investment in equity funds, which is nothing but the stock market, and in debt funds, which is fixed income security that deals mainly with bonds. Bonds are always given ratings based on the credit quality, the financial strength of the company that issues the bond and the ability of the company to pay interest and repay the principal amount. These ratings are denoted as AAA, which is the highest, then AA, A, BBB, BB, B and so on and so forth.
Now when it comes to credit risk funds, they are actually a type of debt funds that are mainly invested in bonds that are rated AA or lower. To be more specific, credit risk funds invest about 65% of the fund in lower than AA rated bonds. Since these bonds do not have the strength of higher rated bonds, their repayment and interest are not a sure thing and hence the ‘risk’ in its name itself. But if they’re risky, why do people invest in them? Let us explain.
Because credit risk mutual funds invest in lower rated bonds, the bond issuer pays more interest to the investor. Secondly, if and when these bonds become better rated, the capital gains achieved can be high, and the investor gets higher than normal returns for their investment.
Despite being a type of debt fund, credit risk funds have risks associated with them. It is entirely possible that instead of the bond ratings improving, they go further down. This up and down is part of credit risk funds, and only those investors that have a high appetite for risk should invest in credit risk funds. Investors looking for low risk, and relatively stable forms of investment that give an average, but steady returns can avoid credit risk fund.
Since credit risk funds are a type of debt funds, they’re taxed with short term capital gains tax for up to 3 years and with long term capital gains tax for more than 3 years. The short term gains tax will be according to the income tax slab that the investor belongs to. The long-term gains tax for debt funds is 20%.
To conclude, credit risk funds can be a good way to earn higher than normal returns by investing in lower rated bonds. But, as is the case in almost every aspect of an investment, whenever the rewards can be great, the probability of risk also rises. For those of you who are willing to take those risks in order to get excellent returns, then these credit risk funds might be your cup of tea.