What Are Debt Funds & Who should Invest in them.

What are Debt Funds

Debt funds are a type of mutual fund that primarily invests in fixed-income securities such as government bonds, corporate bonds, and other debt instruments. They are considered relatively safer investment options compared to equity funds because they offer a fixed rate of return.

 

What are the various options for an investor in a debt fund?

Based on an investor's risk appetite and time frame of investment an investor can choose from various categories of debt mutual funds that are available.

Investors with a short time frame of one day to 3 months can use overnight or liquid funds investors with a time frame of 3 months to a year can use ultra-short-term funds.

Investors with a time frame of one to 3 years can use short-term funds or medium-duration corporate bond funds.

investors looking to capitalize on a fall in interest rates and on a capital appreciation can use long-tenure Gsec funds that have a maturity of upwards of 3 years those eyeing visibility of returns can choose a target maturity fund

 

How do these funds earn a return?

Debt scheme earns in 2 ways namely interest payments from its bond holding which generates interest and secondly as and when interest rates fall or rise bond prices move up and down resulting in loss or gain both the gains or loss combined together in the final return for the investor

 

What are the advantages?

Debt funds enjoy high liquidity.  A redemption request once placed before the cut-off time ensures money comes into your bank account on the next working day. One can switch among various debt schemes anytime based on changing requirements. In fixed deposits, if one needs money in an emergency, she needs to break the full deposit while in a debt fund, one can redeem the required number of units or amount. Most bank levy a prepayment penalty on fixed deposits if withdrawn before the maturity date.  There is no such penalty in debt funds.  When interest rates begin to fall there is a scope of Capital appreciation in a debt fund that does not exist in other fixed-income products investors can redeem small amounts.

 

Here are some key points to remember about Debt Funds

1.     Types of Debt Funds: There are different types of debt funds based on the duration of the underlying securities they invest in. Some common types include liquid funds, ultra-short-term funds, short-term funds, income funds, and gilt funds.

 

2.     Investment Objective: Debt funds aim to generate stable income for investors while preserving the capital invested. They are suitable for conservative investors who seek regular income and have a lower tolerance for risk.

 

3.     Risk and Returns: Debt funds are generally considered less risky than equity funds, but they are not completely risk-free. The risk associated with debt funds primarily stems from interest rate fluctuations, credit risk (default by issuers), and liquidity risk. The returns from debt funds are usually lower than equity funds but relatively more predictable.

 

4.     Taxation: Debt funds in India as per the new rule from 01 April 2023 are taxation as per the tax slab of the individual.  Now Capital Gain/loss is no more applicable to Debt Funds anymore and the indexation benefit is also removed.

 

5.     Suitability and Investment Horizon: Debt funds are suitable for conservative investors, those with a short to medium-term investment horizon, or individuals looking to diversify their investment portfolio. It's important to choose a debt fund that aligns with your investment objectives and risk appetite.

 

Remember, it's always advisable to consult an expert financial advisor or conduct thorough research before making any investment decisions.

 

Suman Manjrekar