Should you run an SIP in debt funds?

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SIPs have become a byword in mutual fund investing. The touted benefits are many, from avoiding market timing errors to averaging costs lower to investing small amounts. Does an SIP in debt funds also tick all these boxes? Or will you be better off with making lump-sum investments?

The truth is this:

  • Like in equity, a SIP in debt funds has its uses in terms of regular savings for your asset-allocated long-term portfolios. This remains the primary and most important reason to do SIP and is never irrelevant – whatever be the interest rate cycle.
  • Rupee cost averaging works better in volatile asset classes. Since debt is not as volatile as equity, in general, you cannot expect this aspect of SIP in debt funds to work efficiently, like it does with equity funds.
  • You can effectively curb volatility by simply investing and holding a fund for the duration for which it ought to be held (based on which category it belongs to). If you can do this with discipline, then you can do without SIPs.
  • However, in our experience, most investors tend to get jittery when some categories of funds return negative in a rate hike scenario. Seeing large lumpsums in their debt portfolio being eroded is not something that investors handle when they add debt for stability. For this reason, SIPs simply provide you the comfort that they are handling the volatility. Do read this article we authored on Moneycontrol about the negative return possibilities in some categories of debt like gilt. For most of you who invested in gilt based on the recent double-digit returns, you will see a different performance picture when rates start moving up. You will need resolve in such periods to invest lumpsum!

Now, let’s move on to elaborating this.

Why should you SIP?

Whether in equity or in debt, know that SIP does not guarantee better returns than lump sums. In the hankering for returns and getting timing right, the primary reason to run an SIPs is swept aside: a SIP is first a saving strategy. It is typically part of an asset allocated portfolio where you simply cannot invest a large sum in one shot and do so over a period across equity/debt/gold.

Because it is automated, you don’t forget to invest or sit on the sidelines awaiting a correction. Because you can invest any amount, it helps you begin wealth building using whatever surplus you have as early as you can. Because it allows gradual accumulation, you don’t need a huge amount to reach your goal right from the outset.

Takeaway: Never lose sight of the primary purpose of SIP. It is for disciplined savings when you cannot put away a large sum in one shot. When we give debt in asset-allocated portfolios, this is the assumption.

Why SIP in debt funds is not the same as in equity

SIPs thrive and grow in volatility. You need periods of NAV hikes and falls to rupee-cost average. Such fluctuations come by with relative ease in equity funds since stocks are inherently volatile. In debt, however, volatility is much lower. Your ability to take the benefit of volatility by investing at different times through a SIP in debt funds is limited. The table below shows the volatility in equity and debt fund categories based on 1-month returns since 2010. The most volatile category in debt funds is the gilt category, followed by dynamic bonds which change strategies based on rate cycles. But volatility here pales in comparison to the least volatile equity category, which is large-cap funds.

Needless to say, by volatility, you only think of the ‘dip opportunities’ to average. When the dips are not steep – which is the case with debt funds – the impact of this cost averaging is minimal. Barring write-downs due to credit events, debt funds do not see big loss-making periods. See the table below  – it shows the worst 1-year returns, on an average, for each debt fund category in the past decade.

While individual funds may have fallen more (mostly due to credit risks materialising), generally losses are not big enough for a SIP in debt funds to help average much.

Takeaway: Debt funds, by their very nature, are low on volatility and do not undergo deep shocks (save for credit default events). This makes them less responsive to SIPs than equity funds.

SIPs in gilt and dynamic bond

In our data (above) on volatility, you saw some categories being more volatile than others. This stems from the nature of instruments the fund invests in and its strategy. Bond prices react to interest rate changes, and bond price changes cause the NAV to move. Longer duration bonds react more sensitively to rate changes than shorter duration bonds.

In terms of strategy, accrual-based funds do not see much volatility because their aim is not to tweak strategies to gain from bond price rallies. But bond prices do move due to rate cycles, especially those from AAA companies and PSUs. Therefore, accrual categories such as corporate bond, short duration, and banking & PSU do see some volatility, but this rarely translates into SIP performance being much better.

This leaves funds that gain from duration – i.e., returns come from catching bond price rallies on falling rate cycles. Gilt funds come at the top here, since gilt instruments are the main route to a duration strategy. The second is dynamic bond funds, which switch between accrual and duration based on the rate cycle. This is where an SIP in debt funds can come into use. In the early stages of an interest rate cycle changing from falling to flat or rising, dynamic bond and gilt funds can see their returns dip. The table below shows the proportion of times these funds delivered losses across different timeframes in the past decade. And do note that this is including the funds which saw write-offs due to papers downgraded or defaulted.

Using an SIP in these periods can help catch this volatility. For example, say you started an SIP in SBI Magnum Gilt in January 2017 and ran it to date, which means that you cover a period where gilt yields were rising and then fell. Your IRR would be 9.75%. While not strictly comparable, a one-time investment in January 2017 would have yielded an annualised 7.78%. Similarly, an SIP in ICICI Pru All Seasons Bond delivered an IRR of 9.15% against a lump-sum return of 7.71%.

Do note the following carefully:

  • The above volatility arose because it was a 3-year period – lower than what a gilt fund ideally needs (5 years and above). The volatility and return differential turns irrelevant if you hold them to the desired time frame. The next point explains that.
  • If the SIP in the same SBI Magnum Gilt was done from 2013-2020 (going through multiple rate cycles) the lump-sum and SIP return differential is very low, at 10.15% and 9.9%, respectively. The same holds true for a SIP between 2015-2020. And no, it does not matter if you have a weekly SIP instead of a monthly SIP.

Takeaway: In relatively volatile segments (long duration) like dynamic bond, long term, gilt or constant maturity – SIPs help you tide over the bouts of volatility if there are rate hike cycles during the tenure of your holding. But as you hold them for longer term, it won’t matter one way or the other. In other words, if you do not bat an eyelid as you see your long duration funds fall, and see them through your planned time frame, you don’t necessarily need a SIP in debt funds.

What you should do

If you are running SIPs in debt funds, please let in run – be it for disciplined savings or because you are running a long-term asset allocated portfolio with SIPs across asset classes.  But note the following points:

  • There is no harm doing SIPs for very short duration categories. For example, you can build a large emergency corpus with SIP if you cannot do so in a lumpsum. SIPs will neither help nor hamper your returns for short-term periods that you use for less than 3 years. Such categories are: short duration funds, banking & PSU, ultra-short/low/money market/floating rate/liquid funds. You can invest as per your your convenience.
  • Where you are investing for over 3 years in accrual-based funds – in the corporate bond, medium duration or even banking & PSU, SIP is unlikely to accord you any significant benefit in terms of returns or averaging. Here again, it is a matter of your convenience as to investing through a SIP vs lump sum.
  • If you are investing in gilt funds (including constant maturity) or dynamic bond funds, you need to have a 5+ year horizon. If you will hold them to this time frame irrespective of falls, then lumpsums should be just fine. But if you cannot afford a large sum or if you enter such categories in a low rate cycle (when rates are going to move up) SIPs can be useful to tide near-term volatility.

The biggest takeaway is that you can avoid the risk of mistiming (such risk being high in equity) in debt by holding funds to their minimum time frame. That is the only risk mitigator – it is neither lumpsum nor SIP in debt funds. Our Prime Portfolios and Prime Funds, which feature debt funds across different types are all built for lump-sum or SIP investing. We do this by ensuring we set the right ‘minimum time frame needed’ for each category of fund.

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18 thoughts on “Should you run an SIP in debt funds?”

  1. Interesting post. Well organized as usual.
    One of the things I wonder is given the low rates of return on many of these funds/instruments. Why should one invest in debt funds, if you already have a mix of equity and FDs.

    1. Taxes, for one, especially if you are in the higher tax brackets. Two, you lock into rates in FDs. So when rates are good, an FD could well deliver better. But open-ended debt funds can adjust portfolios to changing rate cycles, which helps when the cycle turns up rather than locking into FDs. This apart, in an FD, you will always have to reinvest at maturity, if you are to maintain your investments and allocations. So you may not always have the best of returns. In a debt fund, you simply have to hold through the cycles until you actually need the amount – the fund makes the changes based on the rates. – thanks, Bhavana

  2. Hi Bhavna,

    I have a huge allocation of assets in debt (60%) compared to equity (40%). How do I plan a SIP given that the market is at an all-time high? I want to achieve an 80% equity to 20% debt ratio.

    Kind regards!

    1. Keep the SIP/STP duration long enough like 18-24 months so that you capture any dips. Nothing otherwise that can be done as one cannot wait for a correction to happen 🙂 thanks, Vidya

  3. Hello mam,
    My question is. say for example:-
    if i invest one lakh in a medium term debt fund for the horizon of 5 years.
    And at the time of the investment if the fund (bond) ytm was 6%
    And after one year
    if interest rate goes up and my fund (bond) ytm goes to 7%
    At this time if invest additional one lakh into my fund.
    Than can i expect return of ytm 6.5% from my invested two lakh capital.
    Thank you. Regards

    1. Hello sir,

      No, YTMs don’t work that way. YTMs (net of expense ratio) are an indicator of your potential returns when durations are very short. In longer maturities, the YTMs will change as and when the underlying portfolio changes. It is not the average of the YTMs at the times you entered. Two, there can be elements of bond price gains or losses through the years, which changes the returns.


  4. Nice article, please confirm which is the best option for parking emergency fund, & which one for temperory tactical allocation. I am thinking about Axis short duration fund or PSU fund, the other option is Kotak arbitrage fund especially considering the tax advantage.
    Also, request you to let us know when the portfolio evaluation / MF review tool would be available.


      1. Thanks Bhavana, clear & precise answer, as always.
        Appreciate the great support of Prime Investor team

      2. I was referring to Prime portfolio review, which I guess has not yet started. But, I can review the funds individually through the MF review tool.

        1. Hello sir,

          You mean an entire portfolio review…well, that’s a work in progress 🙂 Our SEBI certification at this time permits us to give product-specific recommendations, and not individual advice customised to each portfolio. We’re working on making the MF Review Tool more dynamic, informative, actionable, and easier to use, but it will take a good bit more effort and work before we put it out. Do give us some time 🙂


  5. Sunil Hareendran

    I am skeptical on the market as a whole :-
    “The withdrawal of money [from debt] is greater and more sudden than in 2008, the economic shock is huge and the path to recovery more uncertain than it was after the last crisis (even though the markets are at high now). This pandemic will quickly escalate from a health crisis, and ultimately to a solvency crisis” .
    “This crisis will be much deeper and more prolonged than we a anticipate.”
    Would appreciate a guidance or thought on :- how should we go about investing (only to use safer fund types and stay invested)?

  6. Pawandeep Singh Chhabra

    Hi Bhavna, Thanks for articulating it very well with sight on what is happening in debt market over last month or so with returns turning negative for large chunk of funds.
    Have a query, on holding period for corporate bonds and Banking / PSU funds. The broad holding period of 3 years to ride volatility is irrespective of papers which fund holds or depends upon maturity of papers also ?

    Thanks in advance.

    1. Hello sir,

      The general holding period is 2 to 3 years for banking & PSU funds. For corporate bond funds it needs to be at least 3 years – mostly because the fund can change its maturity profile from short to medium term depending on rates and therefore it’s just safer to have a longer horizon here. Maturity of the papers is important – but sometimes, funds may take different paper maturities as tactical calls and you will need to be able to identify that. This anyway is not necessary for you to analyse, and you don’t need to go strictly by the fund maturity. Just keep the minimum required timeframe in mind and then invest. You won’t go wrong by much. It’s fine to have shorter maturity funds for a longer timeframe.


      1. Pawandeep Singh Chhabra

        Thank you for clarifying in utmost simple terms Bhavana. Appreciate !
        Kind Regards !!

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