Debt funds that invest in securities that generate a fixed amount of income like corporate bonds, commercial papers, treasury bills, government securities and many more money market instruments. All of these instruments have a maturity date that is pre-decided and an interest rate that the buyer can earn on maturity, therefore the name fixed-income securities.
Debt mutual funds are also considered low risk since the returns generated from such securities are not affected by the market fluctuations and trends.
Different types of Debt Mutual Funds
On the basis of its maturity period, debt funds can be categorised into the following types:
- Money market funds
Funds that invest in the money market instruments with a maturity period of not more than a year. They are good for investors that seek low-risk debt securities for a short period of time.
- Liquid fund
Funds that invest in money market instruments with a maximum maturity period of 91 days. They tend to offer better returns than savings accounts and are a good alternative for a short-term investment.
- Corporate bond fund
These types of funds invest a minimum of 80% of their total asset in corporate bonds that have the highest ratings. They work well for investors with lower risk appetites and who want to invest in high-quality corporate bonds.
- Dynamic bond fund
Another type of debt mutual fund is the dynamic bond fund. They invest in debt instruments that have varying maturity dates on the basis of the interest rate regime. They are suitable for investors that have moderate risk tolerance and an investment horizon of 3 to 5 years.
Benefits of investing in Debt funds
- Offers a stable income: Debt funds have the potential to offer capital appreciation over a period of time. While debt funds come with a relatively lower degree of risk than equity funds, the returns are not guaranteed and are subject to market risks.
- Tax efficiency: if tax reduction is a feature you are looking for, debt mutual funds is just the right direction you are looking towards. This is because debt funds are more tax-efficient than traditional investment options like Fixed deposits (FDs).
- High liquidity is offered: Debt mutual funds have no lock-in periods, however, some funds can exit load which is a charge that is deducted at the source for premature withdrawals. The exit load may vary from fund to fund where you may come across some funds with no exit loads at all.
- Flexibility: debt mutual funds offer you the option of moving your money to different funds. This is possible through a Systemic Transfer Plan (STP). this way, you can spread the risk of equities over a specified period of a few months rather than investing the entire amount at one point. Figuratively, it prevents “putting all your eggs in one basket”.
- Stability: investing in mutual debt funds can increase the balance of your portfolio. By investing in Debt funds, one can adequately diversify a portfolio and bring down overall risk, thereby “cushioning the downside”.