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      What are Debt Funds and why you should invest in them
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      April 25, 2023
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      A mutual fund strategy known as a debt fund invests in fixed income securities. Bond funds and income funds are other names for debt funds. This article discusses all the details about debt funds, what they are, how investing in debt funds can be beneficial for investors, who should invest in them, and more.

      Debt funds can be a very good option to ensure steady and low-risk returns. It’s a mutual fund scheme that invests in various instruments such as Corporate and Government Bonds, corporate debt securities, money market instruments, etc. Debt funds are also known as Fixed Income Funds or Bond Funds.

      Who should invest in Debt Funds?

      Debt funds are ideal to invest in for you, if:

      • You are seeking regular income: Debt funds invest in high-quality AAA bonds for fewer durations, making them an ideal investment option for conservative investors looking for a steady income to meet their regular expenses. 
      • You are a risk-averse or new investor: Investors who want to avoid risky investments (equity funds) can consider debt funds such as short-duration funds or corporate bonds. Debt funds can generate better returns than bank fixed deposits, especially in the case of declining interest rates. These funds offer adequate liquidity and flexibility in redeeming the fund units.
      • You want to invest in short-term funds: Investors who have idle money can make short-term investments in liquid or ultra-short duration funds. These funds give you better returns than FDs and act as emergency funds that you can dissolve in case of any emergency. You can opt for a fixed maturity plan if you have a specific investment horizon.

      Taxation of debt funds: 

      Debt funds get taxed like other mutual funds. The capital gains realized from the funds are taxed based on how long the investor holds fund units.  

      If an investor redeems the units before three years, capital gains on redemption/sale will fall into the category of short-term gains and get taxed as per the investor’s income tax slab rate. When the investor redeems the units after three years, the capital gains are considered a long-term gain and taxed at 20% with indexation benefit. Indexation benefit means the purchase prices are increased as per the inflation to calculate capital gains.

      What is the risk associated with Debt Fund investment?

      Debt funds carry various risks and thus need investors’ consideration.

      • Credit risk: The investor’s fund portfolio may also face credit risk. When a credit rating downgrades security, its value decreases in the market, affecting the investor’s portfolio.
      • Interest rate risk: In this situation, the value of a bond or other fixed-income investment suffers because of a change in the interest rates.
      • Liquidity risk: Liquidity risk delays returns from investments. It occurs in such a situation when the sale unit volume is higher than the security buyers in the market. As a result, investors find it difficult to redeem their money. 

      Returns of debt funds concerning the time 

      Funds with less than three years of maturity are ideal for short-term holdings as they can balance themselves in fluctuating interest rates, which means that a fund with lower than average maturity brings greater certainty and lowers volatility. 

      If you hold the units for more than their average maturity, you may not get better results. So toget the most out of debt funds, consider your investment horizon in line with the average maturity of the scheme.

      Advantages of debt mutual funds 

      Some of the significant advantages of investing in debt funds are as follows. 

      • Offers Decent returns: Debt funds offer investors a stable rate of returns without being affected much by the market conditions. Investors with a low-risk appetite and specific investment horizon can select debt funds instead of fixed deposits as they are much more likely to perform better. 
      • Ability to hedge against volatility: Debt funds don’t get much affected by market volatility. They can compensate for the volatility of equity funds. A good mix of debt and equity funds helps diversify your portfolio and stabilize the returns. The concentration of debt funds in a portfolio will depend on the investor’s financial goals, investment horizon, and ability or willingness to bear risk. 
      • Highly liquid funds: Debt funds offer sufficient liquidity to investors to cash out their money more quickly than other investment options such as FDs that come with a mandatory lock-in period. Debt funds act as emergency funds that can be easily dissolved in need of extra cash in hand.
      • Lower Transaction Fees: Debt funds attract fewer transaction fees in the redemption of units than equity and other mutual funds. They are low-risk funds and don’t attract TDS. However, a specific tax will be levied depending on the investment horizon if the investor sells the fund units. 

      Why should you invest in debt funds? 

      There are many advantages of investing in debt funds, such as they offer a low-cost structure, decent returns, high liquidity, and lower risks. Debt funds also score over other investment options for post-tax returns. The dividends from debt funds are tax-free in investors’ hands. However, a Dividend Distribution Tax has to be paid by the mutual funds. These funds are the best alternative for investors who want to get exposure to the mutual fund arena but don’t have a high bearing risk capacity to invest in equity funds.

      Conclusion

      Debt funds are ideal for investors who want to generate stable incomes while minimizing their exposure to market risk. Investors can choose from various debt funds, such as liquid and ultra-short debt funds, as per their financial goals and time horizon.

      FAQs

      Have any queries related to debt funds? We got you covered through this FAQ section.

      1. How do debt funds work?
        1. Ans: Debt funds majorly invest in listed and unlisted debt instruments, such as Corporate and Government Bonds, where these instruments are purchased at a certain price and sold at a margin. The difference in purchase and selling prices decides the appreciation and depreciation in the NAV of the fund.
      2. Is investing in debt funds a good option? 
        1. Ans: Yes. Debt funds are ideal for investors who want to preserve capital and earn better post-tax returns than bank FDs. These funds are also suitable for fulfilling near-term goals.
      3. Do debt funds come with a lock-in period? 
        1. Ans: No. Debt funds don’t have a lock-in period, making them easier to redeem when needed.
      4. How to select a debt fund? 
        1. Ans: For selecting the best debt fund for investment, investors must consider their investment horizon and the category of fund they want to invest in. Go for an AMC with an outstanding track record and offer portfolio management services with a minimal expense ratio.

      Disclaimer: This blog has been issued on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this document is for general purposes only and not a complete disclosure of every material fact. The information/data herein alone is not sufficient and shouldn’t be used for the development or implementation of an investment strategy. It should not be construed as investment advice to any party. All opinions, figures, estimates and data included in this blog are as on date. The blog does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on our current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Readers shall be fully responsible/liable for any decision taken on the basis of this article. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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