Your money in 2026: Go for dynamic bond funds to get best of both worlds next year – here’s why

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Debt funds have offered a mixed bag in 2025. Credit risk funds delivered double-digit returns, and even short-term and medium-term funds gave decent returns of 7-7.5%, but long-term debt funds floundered at 2.8%. This has surprised everyone because interest rates were cut quite sharply during the year, which should have pushed up bond prices.But despite big rate cuts, bonds faced selling pressure and the benchmark 10-year government bond yield remained decidedly above 6.5%. Even dynamic bond funds, which actively manage the interest rate risk by shifting between instruments of different maturities, have given only 5.2% during the year (see table).How debt funds fared in 2025

Data as on 23 Dec 2025. Source: Value ResearchExperts say further rate cuts may not happen, so bond yields are likely to remain rangebound. This means the insipid performance of long-term bond funds in 2025 may get repeated in the coming year. On the other hand, the accrual strategy of short-term funds could deliver steady returns without leaning too much on a rate cut. Investors can bet on these funds without taking on a duration risk.For investors, the best strategy in 2026 would be the barbell approach that allocates across both short-term and long-term debt funds, thereby creating balance. Investors should allocate 50% of their fixed income portfolio to short-term bond funds, about 30-35% to medium-term funds and the remaining 15-20% to long-term bond funds. Such diversification can provide stability as well as maintain exposure to medium- or long-duration funds so that investors don’t miss out if yields soften.Feeling unsure whether to go with long duration funds for big gains when bond yields come down or stay in short and medium-term funds for stable returns? Let the fund manager take the call on your behalf by opting for dynamic bond funds. These schemes have the flexibility to invest in bonds of different maturities. The category delivered average returns of 5.15% in 2025, but this is because even fund managers were caught off guard when bond yields remained elevated despite rate cuts.The adaptability of dynamic bond funds allows investors to hold the fund for longer periods. Though the category average is not very impressive, the best performing dynamic bond funds have delivered very good returns for investors in recent years (see table). Debt funds may have lost their edge over fixed deposits from a taxation perspective, but they offer other advantages such as higher liquidity and greater flexibility. Best performing dynamic bond funds

Data as on 23 Dec 2025. 3-year returns are annualised. Source: Value Research