May 19, 2024

Moo Trade

Finance Blog

Know What is Debt Funds & How Debt Mutual Funds Work

Debt and equities are the primary types of mutual funds available in the market. Several investors choose debt funds over equity funds due to the lower risk. Moreover, debt funds can bring stability to an investment portfolio with income from fixed-income securities. 

But what is debt fund? Keep scrolling to explore various details about debt mutual funds. 

Understanding Debt Funds

The assets from a debt fund are invested in securities generating fixed income like commercial papers, treasury bills, government securities, corporate bonds, and other money market instruments. The instruments that a debt fund invests in have a fixed maturity date.

An interest rate will be applicable, and the buyer will receive the accumulated interest on maturity. The returns from a debt fund don’t vary according to market conditions. Therefore, debt funds are a low-risk investment option. 

Who Should Choose Debt Funds?

Debt funds are perfect for investors with a low-risk tolerance. Debt funds can diversify your portfolio across different securities to deliver stable returns. While the return isn’t guaranteed, it usually falls within an expected range. Short-term and medium-term investors can also choose debt mutual funds.

  • Short-term investors: Investors with a time horizon of 3 to 12 months can choose debt funds. Instead of keeping your funds in a savings account, you can choose debt funds to get 7-9% returns.
  • Medium-term investors: Investors with a time horizon of 3 to 5 years can also choose debt funds. Usually, bank fixed deposits are the chosen low-risk instrument for medium-term investments. But debt funds will offer better returns than FDs. You can go for a Monthly Income Plan if you need monthly payouts.

Benefits of Debt Mutual Funds

A few benefits of debt mutual funds are as follows:

  • High liquidity: Debt funds don’t have a lock-in period, and you can withdraw them at any time. But you will have to bear applicable exit loads to withdraw from debt funds.
  • Stability: Debt funds are less volatile than equity funds and can stabilize an investor’s portfolio. Therefore, debt funds can reduce the overall risk of an investor.
  • Tax benefits: Debt funds are taxed only when they are redeemed, and the tax amount will only be calculated on the redemption proceeds. Unlike traditional investment instruments, debt funds don’t deduct TDS on the yearly interest amount.

Conclusion

You will come across debt funds with different durations that can last till 7 years. You can even opt for a debt fund that offers regular income. Analyze your financial goals and investment horizon to pick the best debt fund. 

FAQs:

  • What is the difference between debt funds and other mutual fund schemes?

Debt funds are not much different from other mutual fund schemes in terms of operation. But in terms of safety, debt funds are much better than equity funds. Meanwhile, debt funds can offer moderate returns compared to equity funds. 

  • How can debt mutual funds generate returns?

Debt mutual funds can generate returns by investing pooled assets in fixed-income securities like bonds. These debt funds purchase bonds and generate interest income on that. The returns of a debt mutual fund are based on the interest income. 

  • Are FDs better than debt funds?

FDs and debt funds are suitable for long-term investments. But you will have to pay the penalty for making a partial withdrawal from an FD before its maturity. In the case of debt funds, you can make partial withdrawals without any penalties.  

  • Is lump sum investment better than SIP for debt funds?

Lump sum investments are suitable for investors who want to invest in debt mutual funds for the short term. SIP investments are not suitable for debt funds because they have a recommended time horizon of less than three years. But that doesn’t mean you cannot make SIP investments for debt funds. 

  • How does a rising interest rate affect debt mutual funds?

Higher interest rates lower the value of existing debt instruments in the market. It happens because high-interest rates attract investors toward debt funds that offer high interest. 

Disclaimer– Mutual Fund investments are subject to market risks; read all scheme-related documents carefully.

About The Author