Debt is the major market in which people invest their hard-earned money to make profits. The debt market consists of various instruments which facilitate the buying and selling of loans in exchange for interest. Considered to be less risky than equity investments, many investors with a lower risk tolerance prefer buying in debt securities. However, debt investments offer lower returns as compared to equity investments.
Here, we will explore Debt Funds and discuss different types of debt funds along with their benefits more.
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Debt funds invest in securities that generate fixed income, like treasury bills, corporate bonds, commercial papers, government securities, and many other money market instruments.
All these instruments have a pre-decided maturity date and interest rate that the buyer can earn on maturity - hence the name fixed-income securities. The returns are usually not affected by fluctuations in the market. Therefore, debt securities are considered to be low-risk investment options.
Now that you know the debt funds meaning, let’s understand the major characteristics of these funds:
Debt funds usually diversify across various securities to ensure stable returns. While there are no guarantees, the returns are usually in an expected range. Hence, low-risk investors find them ideal. These funds are also suitable for short-term investors and medium-term investors.
Debt mutual funds offer lower returns than equity funds. Also, there is no guarantee of the returns. The NAV of such funds fluctuates with changes in the interest rate. If the interest rates rise, then the NAV of these funds falls and vice-versa.
Debts funds fundamentally carry three types of risks:
Based on the maturity period, debt funds can be classified into the following types:
Every debt security has a credit rating, which allows investors to understand the possibility of default by the debt issuer in disbursing the principal and interest. Debt fund managers use these ratings to select high-quality debt instruments. A higher rating implies that the issuer is less likely to default.
You can invest in debt funds directly through AMC, or you can opt to invest via Groww.
You just have to download the Groww application from the Play Store or Appstore and complete the registration and KYC process to invest.
The main reasons that drive investment in debt funds are:
Investing in a debt fund allows you to earn interest as well as capital gains on debt. It gives retail investors access to money markets and wholesale debt markets, both of which they cannot invest in directly.
These funds are offered throughout the whole maturity and credit risk spectrum. Short-term funds produce consistent and predictable income. Longer-duration funds earn interest as well as capital gains and are appropriate for investors who can tolerate higher NAV volatility.
Overnight funds, liquid funds, corporate bond funds, and short-term funds typically invest in the most secure debt securities. To deliver better returns, ultra-short and short-duration funds may be constructed to take on credit risk.
Since debt mutual funds are less risky than equity funds, allocating a portion of an investment portfolio to the best-performing debt funds minimizes risk and adds stability. Tactical investments in these funds are effective for capitalizing on short-term yield opportunities.
These funds are extremely liquid and can be redeemed fast, usually within one or two working days of the redemption request being made. There is no lock-in or fixed period, unlike bank fixed deposits or recurring deposits. While a few funds may levy a minor exit cost for early withdrawal, in general, there are no penalties for withdrawing a mutual fund investment.
In the case of Debt Mutual Funds, the taxation rules are as follows:
If you hold the units of the scheme for a period of up to three years, then the capital gains earned by you are called short-term capital gains or STCG. STCG is added to your taxable income and taxed as per the applicable income tax slab.
If you hold the units of the scheme for more than three years, then the capital gains earned by you are called long-term capital gains or LTCG. LTCG is taxed at 20% with indexation benefits.
Q1. Is a debt fund beneficial or detrimental?
Individual financial goals and risk preferences influence whether something is good or not. It is an excellent choice for investors wanting stability, consistent income, and lower risk. However, if an investor wishes to take on more risk while earning larger returns, it is not a smart alternative because it provides lesser returns than equities.
Q2. How do debt funds operate?
Debt funds invest in fixed-income assets such as corporate and government bonds and other debt instruments. It profits from the interest and price appreciation of the debt instruments it invests in.
Q3. What are the risks involved in debt funds?
Debt Mutual Funds are subject to mainly credit risk and interest rate risk.
Q4. Are debt funds better than equity funds?
Usually, debt mutual funds are less risky than equity funds, but their respective performance depends on market conditions.
Q5. Are debt funds more secure than FDs?
Debt mutual funds and fixed-income investments have various risk characteristics. While fixed-income investments are often considered safer due to their fixed interest and deposit protection, debt funds do contain some risk due to credit risk and interest rate risk.
Disclaimer - Mutual Fund investments are subject to market risks; read all scheme-related documents carefully.
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