Funds ka Funda: Understanding Fixed Income, Debt Funds and Portfolio Stability

Introduction

Vidhi Mehta:Hello everyone and welcome to Funds ka Funda. In today’s episode, we are simplifying fixed income for retail investors — the real differences between fixed deposits, bonds and debt funds, the actual risks involved, the role of life-stage planning, and the right way to think about emergency money.

Joining us today is Kruti Chheta from Mirae Asset Mutual Fund. Hi Kruti, welcome to the show.

When we talk about fixed income, it can feel quite confusing. For most people, there is a general perception that FDs are safe and offer stable returns. Bonds, on the other hand, may offer higher returns, but the risks are less visible. And then debt funds seem to offer flexibility.

So if a common investor wants to understand fixed income through this framework, how accurate is that understanding?

Fixed Deposits, Bonds and Debt Funds: What Really Sets Them Apart?

Kruti Chheta: There is definitely some truth in that framework, but there are several other factors investors need to think about when it comes to fixed income.

Take fixed deposits, for example. They are considered conservative, but even there, many variables matter. Which bank are you placing the FD with? For what tenure? Can you break it before maturity or not?

So yes, an FD may be conservative, but let us say an investor locks into a five-year FD at 6%, and next year interest rates move to 7%. That investor is now effectively at a disadvantage. And if they break the FD, there may also be a penalty. So it is not entirely correct to say that FDs are completely risk-free. The risks exist, but many investors do not recognise them.

Now if we move to corporate bonds, these are essentially loans you are giving to a company, only in smaller amounts.

Here too, the first question is tenure. Are you comfortable investing for two years, three years, five years or even ten years? Then comes the second question: what is the quality of the company? What is its risk profile? Is it safe enough to continue paying you coupons for that entire period?

If an investor understands all of this, then corporate bonds may make sense. But if not, they need to think carefully before committing to long tenures.

The third and perhaps biggest issue in corporate bonds is liquidity risk.

Even today, the bond market has much higher institutional participation than retail participation. Most transactions in the corporate bond segment tend to happen in sizes of ₹5 crore and above. Retail-sized transactions do happen, but if you are investing a smaller amount, liquidity may not always be available when you need it.

So if your requirement is stability but you may also need money midway, direct corporate bonds can carry liquidity risk.

Now debt funds offer a much better balance for a few reasons.

First, they are far more flexible in terms of liquidity. You can redeem them when needed.

Second, they work across different time horizons whether you need the money in a few days, a few months or a few years.

Third, because they invest in a pool of corporate bonds and other instruments, they can generally offer better yields than fixed deposits.

Also, in a debt fund, when rates move, the portfolio adjusts. In an FD, your coupon does not reset. But in debt funds, if rates rise, the portfolio can gradually realign to higher yields. And if rates fall, you may get price appreciation.

So these are three very different products, and each serves a different purpose.

If someone wants to stay extremely conservative and does not want to think too much, they may prefer an FD. Corporate bonds may suit investors who understand the market and have a higher risk appetite. But for retail investors, debt funds often work best because they combine flexibility, better market participation and lower liquidity constraints.

Should Fixed Income Be Part of Every Investor’s Asset Allocation?

Vidhi Mehta: For a retail investor, do you think fixed income should always be part of the asset allocation mix?

Kruti Chheta: Definitely. The percentage may vary, but fixed income should certainly have a place in the portfolio.

If you are younger and your responsibilities are limited, then naturally the allocation to fixed income may be lower because your focus is more on wealth creation and you have better visibility of future cash flows.

But that does not mean you should ignore near-term planning.

When an individual builds a portfolio, they should look at it through two lenses  wealth creation and wealth preservation.

Wealth preservation essentially means preparing for expenses that are likely to come up in the near term. These may include holidays, family events, education expenses or even a medical emergency.

The idea is that when these expenses arise, they should not disrupt your long-term wealth creation journey. You should be able to meet them from your near-term allocation, while your long-term investments continue uninterrupted.

Now if you move into a different life stage say you have ageing parents, children approaching university age, or other major responsibilities — the fixed income allocation naturally rises. And in retirement, that allocation becomes even more important.

So the exact proportion depends on the phase of life. But at every stage, fixed income serves a purpose. Wealth creation, wealth preservation and near-term planning are all different needs, and fixed income helps address one of those very clearly.

It can also serve as your emergency fund.

Covid is the best example. No one saw it coming, and markets were highly volatile at the time. In moments like that, having a fixed income allocation can be extremely useful.

Emergency Funds: Why This Is Not the Place to Chase Returns

Vidhi Mehta: That brings me to emergency funds. A lot of investors still chase returns even there. They want 10% or 12% even from what they call emergency money. How should investors think about that?

Kruti Chheta: The answer lies in the name itself it is an emergency fund. Emergencies do not arrive with notice.

Covid was the classic example. Nobody had prior warning.

So if an emergency happens and your money is stuck, or the product you chose does not behave the way you expected because you chased an extra 2%, then you may find yourself in trouble exactly when you need liquidity the most.

There is no free lunch in investing. Higher returns usually come with higher risk.

So by definition, emergency money should be placed in high-quality instruments that can deliver moderate returns and, more importantly, remain available when needed.

If an investor wants to take more risk, there are other asset classes and other allocations where that can be done. But emergency money should first serve its true purpose  availability.

The Biggest Misunderstanding About Fixed Income

Vidhi Mehta: In your experience, what is one misunderstanding around fixed income that investors should let go of completely?

Kruti Chheta: I would call it more of a misunderstanding than a myth.

When people hear the term fixed income, they often assume it means the return itself is fixed in all circumstances. They believe that if they lock in at a certain yield, that is exactly what they will keep getting.

But in reality, what fixed income gives you is more accurately described as moderate returns with visibility of cash flows.

It is still a market.

For example, suppose interest rates are cut and you are holding an instrument bought at 7%. If new issuances in the market are now at 6%, then your 7% instrument becomes more valuable and its price goes up.

But when rates rise, the reverse happens. Your existing holding may trade at a discount because new instruments are offering better yields.

So there is market price risk even in fixed income.

That is why the phrase “fixed income” can be misleading. It is not about guaranteed immobility. It is about a category that offers moderate returns and greater cash-flow visibility, but still operates within a market framework.

2025 and the Breakdown of the Old Bond Market Playbook

Vidhi Mehta: You recently made a bold point in one of your market notes that the old playbook has broken. In 2025, rate cuts happened, but bond markets did not behave the way investors expected. What was different this time?

Kruti Chheta: 2025 has been a very unusual year in many ways.

As you said, rate cuts happened, but the expected transmission did not really come through. And this is not just India’s story. It has happened globally.

Normally, in a rate-cut cycle, the shorter end of the curve reacts more quickly, while the longer end tends to move in anticipation. But this time, even the longer end of the curve did not move as expected.

Just to define terms: the longer end of the curve generally means bonds with ten-year and above maturities, while the shorter end refers to the one-year to three-year segment.

Now, in theory, when central banks cut rates, long-duration bonds should also reflect that. But in India, even after significant rate cuts, the expected movement did not fully happen.

Globally, the explanation is rooted in post-Covid macro realities.

Debt-to-GDP ratios rose sharply after Covid. Fiscal deficits widened. Governments across developed economies increased spending significantly, and in many cases they have not narrowed those deficits meaningfully even now.

So first, debt remains elevated.

Second, inflation has come down from peak levels, but it is still not fully back to target in most developed economies.

And third, developed countries are also dealing with ageing populations, which means slower revenue growth but higher spending obligations through social security and support programmes.

So markets are asking: yes, rate cuts are happening, but are the broader fiscal and inflation conditions really healthy enough for long-term yields to adjust meaningfully?

That is why the expected transmission has been weaker in developed markets.

Emerging markets, however, face a different set of issues.

Here, demographics are more supportive, growth is better, and inflation has generally behaved better than expected. But 2025 was also heavily shaped by geopolitics. Tariff announcements from the US and broader external uncertainty kept foreign investors cautious.

As a result, emerging markets saw weaker FPI participation, more currency volatility, and a generally more unstable environment. So even though fundamentals were better than in developed markets, full transmission still did not happen.

In short, developed markets were constrained by their own structural fundamentals, while emerging markets were disrupted more by external factors.

AI-Led Growth: Bubble, Hype or Structural Shift?

Vidhi Mehta: Another major theme today is AI. AI-led growth is increasingly seen as a core market driver. Do you think this is a bubble, or do you think it continues as a long-term trend?

Kruti Chheta: The simplest way to think about it is to ask: is AI already around us, and are we already interacting with it?

Valuations may go up or down, and there may absolutely be phases of hype. But that is true of every major innovation cycle. First comes innovation, then hype, then very high expectations, and eventually normalisation.

We saw this with technology more broadly as well.

So yes, there can be excess in the short term. But what matters more is that AI is no longer theoretical. It is already becoming part of daily life, manufacturing, development and innovation.

That is why, whether it is a bubble in the short term or not, we do know one thing — AI is here to stay for a long time.

There may be volatility, and unrealistic expectations may get toned down. But that is the normal path of every innovation cycle.

Forecasts May Fail, but Flexibility Matters

Vidhi Mehta:
You wrote that forecasts often fail, and those who adapt do not get left behind. If there were one simple takeaway for retail investors, what would it be?

Kruti Chheta: The key takeaway is adaptability.

Two years ago, we did not think AI would become such an important part of our lives so quickly. Similarly, many investors may not have expected gold to re-emerge so strongly as a return-generating asset class.

So when change is visible, investors should not remain rigidly attached to old correlations or old assumptions.

Portfolio allocation should remain flexible.

If one asset class has moved up sharply, or another has become too volatile, investors should be willing to rethink allocations rather than blindly rely on what worked in the past.

That flexibility is what many of the best investors in the world demonstrate.

So the simplest message is this: stay flexible with your portfolio and with your asset allocation.

What Should Fixed Income Investors Focus On Most?

Vidhi Mehta: If you had to answer simply, what should fixed income investors focus on the most?

Kruti Chheta: Flexibility, again.

Just as overall portfolios need flexibility, fixed income portfolios need it too.

Some investors may want to actively track the market and shift categories on their own. Others may prefer to choose a fund where the fund manager makes those adjustments automatically as market conditions change.

For example, one phase may favour duration, but that can change quickly. If an investor wants to put money aside and not monitor it constantly, then choosing a flexible category or a flexible fund becomes very important.

So even within fixed income, flexibility matters.

Conclusion

Vidhi Mehta: Thank you, Kruti, for your time. This was a very insightful conversation.

The broader takeaway from today’s episode is that looking at fixed income only through the lens of FDs, safety and boring returns may be too limited an approach.

In today’s environment, where equity is volatile and macro signals are mixed, fixed income has a much more evolved role. Sometimes it provides stability, sometimes it supports planning, and sometimes it helps balance the overall portfolio.

So how much weight does fixed income have in your portfolio? Do tell us in the comments.

Disclaimer: Investments in securities markets are subject to market risks. Please read all related documents carefully before investing.