Young investors often hear that they have decades ahead of them and can therefore afford to take higher equity risk. While equity can indeed remain the core of a portfolio for long-term wealth creation, experts say this does not mean investors in their 20s or early 30s should avoid debt mutual funds altogether.
Debt can play a role in providing stability, liquidity and diversification, particularly when the investment goal is closer or when market volatility makes it difficult to stay invested.
Being young does not mean going 100% into equity
Sanjiv Bajaj, Joint Chairman & MD, Bajaj Capital, said young investors should not look at the equity-versus-debt decision in black-and-white terms.
A 25-year-old may have a long investment journey and therefore more room to take equity risk. However, investing is not only about pursuing the highest possible return. Having some debt in the portfolio can provide a cushion during periods of equity-market volatility and make it easier for investors to stay invested rather than make panic-driven decisions.
“Debt” therefore need not be viewed as an asset class that holds a young investor’s portfolio back. Instead, it can help the investor stay invested in the higher-risk portion of the portfolio.
Krishanu Choudhary, Director & Unit Head, Anand Rathi Wealth, said the debt component remains important across age groups because it can provide stability, liquidity and diversification.
A combination of assets that are less correlated with each other can help reduce overall portfolio volatility and concentration risk, allowing investors to navigate different market cycles more comfortably.
Asset allocation should depend on the goal, not just age
Instead of applying a formula based solely on age, investors should first ask when they will need the money, Bajaj said.
For example, someone who needs money within the next one or two years may not be suited to a high-equity allocation merely because they are young. Conversely, money meant for a goal 15 or 20 years away has more time to withstand market fluctuations.
Investors should therefore divide their investments into short-, medium- and long-term goals and decide the asset allocation for each goal.
Income stability, existing liabilities and an individual’s actual comfort with market volatility should also be considered. Two people of the same age can have very different financial circumstances, and their portfolios do not necessarily need to have the same equity-debt mix.
Choudhary illustrated this with a 25-year-old investor who has three different goals: a holiday in one year, a wedding in three to five years and retirement in more than 25 years.
For the holiday goal, with a horizon of less than a year, a 100% debt allocation can be considered. For the wedding goal, he suggested an allocation of around 60:30:10 across equity, debt and gold. For retirement, with a horizon of more than five years, a higher equity allocation of around 80:20 across equity and debt can be considered.
The example highlights why age alone cannot determine asset allocation. Equity may remain the primary asset class for long-term wealth creation, while debt can support capital stability and liquidity for nearer-term goals.
Which debt funds should young investors consider?
If a young investor chooses debt funds, Bajaj said he would generally favour simpler, lower-credit-risk categories rather than funds offering higher returns by taking greater risks.
For relatively short-term requirements, liquid funds, ultra-short-duration funds and money market funds may be considered depending on the investor’s time horizon.
Investors should not select a credit-risk fund simply because its returns look attractive. Similarly, longer-duration debt funds should not be chosen without understanding how changes in interest rates can affect their NAVs.
Even conservative debt funds can experience some NAV movement. The more important question is therefore what the money is meant for and how long it can remain invested, rather than which fund has delivered the highest past return.
Choudhary said debt-oriented categories can also be evaluated based on the investor’s tax slab rather than age. For investors in a lower tax bracket, he said target-maturity funds could be considered, while investors in a higher tax bracket could consider arbitrage funds for potentially more tax-efficient post-tax returns, subject to their individual circumstances and prevailing tax rules.
Should debt funds replace an emergency fund?
Experts draw a distinction between an investment portfolio and an emergency corpus.
Bajaj said the core emergency fund should preferably be kept in a savings account or sweep-in fixed deposit because the primary requirement during an emergency is straightforward access to money, rather than maximising returns.
A liquid fund can potentially serve as a supplementary layer for someone who is comfortable with it, but Bajaj would not treat it as a complete replacement for readily accessible cash.
Choudhary said investors can consider liquid funds or fixed deposits for an emergency corpus because they offer relatively high liquidity and have lower interest-rate sensitivity than longer-duration debt funds.
He suggested building an emergency corpus equivalent to six to 12 months of expenses, along with annual recurring expenses such as insurance premiums and children’s tuition fees. Such a buffer can help investors avoid disturbing their long-term investments when an unexpected financial need arises.
The bottom line
For young investors, therefore, the question should not be whether to eliminate debt mutual funds altogether. The more relevant question is what role debt should play for each financial goal, based on the time horizon, liquidity requirement and risk profile.
Debt can provide the stability needed for shorter-term goals and help diversify a portfolio, while equity can remain the primary engine for long-term wealth creation.