Imagine you have worked hard and saved up a good amount of money. You want to find a way to make your money generate better returns than a savings account without taking too much risk. A debt fund may be a good option for you.
This article will help you explore debt funds, their types, pros & cons, how to invest in them and much more. Happy reading!
Debt Funds: Meaning & Explanation
Debt funds or fixed-income funds are mutual funds that pool money from investors and invest in a basket of debt securities.
What Are Debt Securities? When the government or businesses require funds, they often take loans from the public by issuing financial agreements called debt securities.
These securities represent a borrower’s obligation to repay a certain amount of money to the holder of the security on maturity. Debt securities promise a fixed income as interest. Hence, these are also called fixed-income securities.
Types Of Debt Funds
Based on specific features, debt mutual funds have many categories. Look at the list below for a brief understanding.
- Overnight Fund– Invests in securities with a maturity period of 1 day.
- Liquid Fund- Invests in securities with a maturity period of up to 91 days.
- Ultra Short Duration Fund- These funds have a Macaulay duration between 3-6 months.
- Low Duration Fund- These funds have a Macaulay duration between 6-12 months.
- Short Duration Fund– These funds have a Macaulay duration between 1-3 years.
- Medium Duration Fund- These funds have a Macaulay duration between 3-4 years.
- Medium To Long Duration Fund- These funds have a Macaulay duration between 4-7 years.
- Long Duration Fund- These funds have a Macaulay duration of more than 7 years.
- Money Market Fund- Invests in money market instruments
- Dynamic Bond Fund- Invests in debt securities of varying maturity periods.
- Corporate Bond Fund- Invests at least 80% of assets in corporate bonds with high credit ratings.
- Credit Risk Fund- Invests at least 65% of assets in corporate bonds with low credit ratings.
- Banking & PSU Fund- Invest at least 80% of assets in banks and PSUs (Public Sector Undertakings).
- Gilt Funds- Invests at least 80% of assets in government debt securities.
- Floater Fund- Invests at least 65% of assets in debt instrument with floating interest rates.
- Fixed Income Index Fund- Invests in funds that track a fixed income index.
Advantages Of Debt Funds
Now, let’s discuss some advantages of debt mutual funds.
1. Better Returns Than Savings Accounts
If you park your money in debt funds, you have a chance to generate better returns on your savings compared to savings accounts.
2. Stable Income
As debt funds invest in fixed-income securities, these funds provide regular interest payments to investors. These returns are much more stable compared to equity funds.
3. Low Risk
In the investment world, debt funds carry lower risk than equity funds or hybrid funds. Hence, these funds are good choices for investors with low-risk appetites.
Related Read: Equity vs Debt vs Hybrid Funds
While some debt funds might have exit loads, most debt funds can be easily bought and sold on the market. This feature is called liquidity.
Disadvantages Of Debt Funds
Debt funds also have some disadvantages. First of all, due to the investments in fixed-income securities, debt funds have limited growth potential and consequently generate lower returns than equity funds.
Second, the issuer always has a risk of default even if debt funds invest in high-quality securities. This credit risk increases even more if the fund invests in some low-rated securities.
Third, debt funds are sensitive to interest rate changes. A minor change can significantly impact the fund’s performance.
What are some examples of debt funds?
Here are some examples of debt funds:
1. SBI Overnight Fund
2. HDFC Liquid Fund
3. DSP Ultra Short Fund
4. Tata Money Market Fund
5. UTI Banking & PSU Debt Fund
Which debt fund is best?
There is no one-size-fits-all answer to this question. It depends on various factors such as an individual investor’s investment goals, investment horizon and risk appetite.
How to invest in debt funds?
How Are Debt Funds Taxed?
According to the latest tax rules, debt funds are now taxed as per the income tax slab rates for both short-term and long-term capital gains.
Who Should Invest in Debt Funds?
As a general rule, debt funds are good for investors with:
1. Short to medium investment horizon
2. Low-risk tolerance.