Debt funds are a type of mutual fund that primarily invests in fixed-income instruments such as government securities, corporate bonds, commercial paper (CP), certificate of deposits (CD), T-bills, and other money market instruments. Debt funds generate stable income for investors in the form of interest or dividend payments.
How Debt Funds Work
Debt funds are managed by professional fund managers who invest in fixed-income instruments such as government bonds, corporate bonds, and other money market instruments. The fund manager aims to generate returns for you by investing in high-quality fixed-income instruments with high credit ratings.
The performance of debt funds is primarily based on the interest rates and credit risk of the underlying investments. When the interest rates go down, the value of fixed-income instruments goes up, leading to capital appreciation for you and vice-versa.
The Role of a Fund Manager in Managing Debt Funds
The fund manager selects the underlying investments based on various factors such as credit ratings, interest rates, and maturity periods. The manager constantly monitors the performance of the underlying investments and makes changes to the portfolio to maximize returns and minimize risks.
Factors Affecting Debt Fund Returns
Several factors can affect the returns generated by debt funds, including:
- Interest Rates: The interest rate of the underlying investments plays a crucial role in determining the returns of debt funds. When the interest rates go down, the value of fixed-income instruments goes up, leading to capital appreciation for you.
- Credit Risk: The credit risk of the underlying investments determines the ability of the issuer to repay the principal and interest. A higher credit rating indicates lower credit risk, which can lead to lower returns for you.
- Inflation: Inflation can reduce the real value of the returns generated by debt funds, as it increases the cost of living and reduces the purchasing power of the money earned from the investment. You need to consider inflation while selecting debt funds for investment.
Advantages of Investing in Debt Funds
- Low Risk: Debt funds are considered low-risk investments because they primarily invest in fixed-income instruments. The returns are more stable as compared to equity investments.
- Steady Income: Debt funds provide steady income to you in the form of interest payments or dividends. This can be a good option for risk-averse investors or those looking for regular income.
- Liquidity: Debt funds are highly liquid, meaning you can redeem your investment anytime you want. This makes them a great option for short-term investors.
- Diversification: Debt funds invest in a variety of fixed-income instruments, which helps in diversifying the investment portfolio. This can help in minimizing the overall risk of the portfolio.
Types of Debt Funds
Debt funds can be broadly classified into various categories based on their investment objective and the duration of the underlying investments.
Here are the different types of debt funds:
#1. Liquid Funds
Liquid funds invest in short-term fixed-income instruments with a maturity period of up to 91 days. Liquid funds provide high liquidity and low-risk investments for investors, making them an ideal option for short-term investments.
#2. Ultra-Short Duration Funds
Ultra-short duration invests in fixed-income instruments with a maturity period of up to 1 year. These funds provide higher returns than liquid funds but come with a slightly higher risk.
#3. Short Duration Funds
Short duration funds invest in fixed-income instruments with a maturity period of 1 to 3 years. These funds are ideal for investors looking for higher returns than liquid or ultra-short duration funds.
#4. Medium Duration Funds
Medium duration funds invest in fixed-income instruments with a maturity period of 3 to 4 years. These funds provide higher returns than short-duration funds but come with a higher risk.
#5. Long Duration Funds
Long-duration funds invest in fixed-income instruments with a maturity period of more than 7 years. These funds are ideal for investors with a long-term investment horizon and looking for higher returns.
#6. Corporate Bond Funds
Corporate bond funds invest in debt securities issued by corporate entities. These funds provide higher returns than government bond funds but come with a higher risk.
#7. Government Bond Funds
Government bond funds invest in debt securities issued by the government. These funds provide low-risk investments and are ideal for risk-averse investors.
#8. Credit Risk Funds
Credit risk funds invest in debt securities with lower credit ratings. These funds provide higher returns than other debt funds but come with a higher risk.
#9. Overnight Funds
Overnight funds invest in debt securities with a maturity period of up to 1 day, making them highly liquid and low-risk.
#10. Floater Funds
Floater funds invest in debt securities that have a variable interest rate, providing protection against rising interest rates.
#11. Gilt Funds
Gilt funds primarily invest in government securities, making them low-risk and ideal for risk-averse investors.
#12. Banking and PSU Funds
Banking and PSU funds invest in debt securities issued by banks and public sector undertakings, making them relatively low-risk.
#13. Money Market Funds
Money market funds are a type of debt fund that invests in highly liquid money market instruments such as treasury bills, commercial papers, and certificates of deposit.
#14. Dynamic Bond Funds
Dynamic bond funds invest in debt securities with varying maturity periods and credit ratings, making them suitable for investors with a moderate risk appetite.
Who Should Invest in Debt Funds
Debt funds are ideal for the following types of investors:
- Risk-Averse Investors: Debt funds are considered low-risk investments, making them ideal for risk-averse investors.
- Those Seeking Regular Income: Debt funds provide regular income to you in the form of interest payments or dividends.
- Those with Short-Term Investment Goals: Debt funds are highly liquid, making them an ideal option for short-term investments.
- Those Looking to Diversify Their Portfolio: Debt funds invest in a variety of fixed-income instruments, making them a great option for diversifying the investment portfolio.
Comparison of Debt Funds with Other Types of Mutual Funds
Debt funds are often compared with other types of mutual funds, such as equity funds, hybrid funds, and index funds.
Here’s how debt funds compare with other types of mutual funds:
#1. Equity Funds: Equity funds primarily invest in stocks, making them a high-risk investment option. Debt funds, on the other hand, primarily invest in fixed-income instruments, making them a low-risk investment option.
#2. Hybrid Funds: Hybrid funds invest in both equity and debt instruments, making them a balanced investment option. However, they come with a higher risk than debt funds.
#3. Index Funds: Index funds replicate the performance of a benchmark index, such as Nifty 50 or BSE Sensex. Debt funds, on the other hand, do not follow any benchmark index.
Go through our list of best brokers for mutual funds investment to know about top brokers to cater to your mutual funds’ investment needs.
Top 10 Best Debt Funds in India
Based on past performance, here is the list of top 10 best debt funds in India.
|Fund||1 Year Return|
|Aditya Birla Sun Life Medium Term Fund||23.1%|
|UTI Bond Fund||14.4%|
|Bank of India Short term Income Fund||12.5%|
|UTI Banking & PSU Debt fund||12.6%|
|Aditya Birla Sun Life Dynamic Bond Retail Fund||9.2%|
|HDFC Fixed Maturity Plan||9.52%|
|Nippon India Income Fund||7.19%|
|ICICI Prudential All Seasons Bond Fund||7.19%|
|ICICI Prudential Short Term Fund||7%|
|SBI Magnum Income Fund||6.49%|
How to Invest in Debt Funds
You can invest in debt funds either through online or offline modes.
#1. Invest in Debt Funds Through Offline Mode
Step #1. You can invest in debt funds by visiting the AMC (Asset Management Company) fund house’s branch office or authorized distributor.
Step #2. Fill out the application form before the cut off time, 1.30 pm.
Step #3. Submit the required documents like KYC (Know Your Customer) details including your PAN card, Aadhaar card, and address proof, and bank account details, and a canceled cheque.
Step #4. Once the documents are verified, select a debt fund which you want to invest in according to your investment time horizon, risk appetite, and availability of funds.
Step #5. Make the payment by cheque or demand draft.
Step #6. The fund house will allocate units based on the prevailing net asset value (NAV) on the day of receipt of the application form and payment.
#2. Invest in Debt Funds Through Online Mode
You can invest in debt funds online through various investment platforms such as Zerodha, Groww, Upstox, and Kuvera.
Now I am taking an example of how to invest in debt funds through Zerodha Coin web or app. You can follow the same process to invest in debt funds with other stockbrokers.
Here are the steps follow to invest in debt funds in zerodha through Coin web or app:
Step #1. Download the Zerodha Coin app from the App Store or Play Store on your smartphone.
Step #2. Login to your Zerodha account using your credentials.
Step #3. Click on the “Mutual Funds” tab on the dashboard. You can also check the step-by step process guide on how to invest in mutual funds in Zerodha.
Step #4. Then click on the “Debt”
Step #5. You can choose any type of debt fund from the list of categories. Suppose you select the “Ultra short duration debt funds” option.
Step #6. Now you can choose the one you want to invest in.
Step #7. Enter the amount you want to invest in the fund and click on the “Buy” button for lumpsum investment. For SIP investment, enter/select:
- Frequency of investment.
- Installment amount.
- Automatic set-up (optional).
Step #8. Click on the “Confirm” button to complete your order.
You may also like to read how to invest in liquid funds in India.
How are Debt Mutual Funds Taxed
Earlier, the tax implications of investing in debt funds depend on the holding period of the investment.
Short-Term Capital Gains: If you sell your debt mutual fund units within 3 years of investment, the gains will be taxed as per your income tax slab rate.
Long-Term Capital Gains: If you sell your debt mutual fund units after 3 years of investment, the gains will be taxed at 20% after indexation.
As per Finance Budget 2023,
From 1st April 2023, debt funds will not receive indexation benefit and capital gains from debt mutual funds are considered as short term gains. Therefore, the capital gains will be added to your taxable income and taxed at your applicable slab rate.
How to Choose the Best Debt Mutual Funds
Here are some factors to consider when choosing the best debt mutual funds:
#1. Understand Your Investment Goals: You need to determine your investment goals, such as regular income or long-term capital appreciation.
#2. Consider Your Risk Appetite: You can assess your risk capacity and choose a fund that matches your risk appetite.
#3. Credit Rating of Underlying Assets: You can choose a fund that invests in high-quality debt securities with a good credit rating.
#4. Expense Ratio: You can choose a fund with a lower expense ratio as it can impact the overall returns of the fund.
#5. Analyze the Fund’s Performance: You can analyze the fund’s performance over the last 1, 3, and 5 years to understand its track record and potential for returns.
#6. Diversification: Choose a fund that invests in a diversified portfolio of debt securities to reduce the overall risk.
The best debt fund to invest in will depend on your investment horizon.
- For short-term investments of 1 day to up to a month, you can go with Overnight Funds or Liquid Funds.
- For up to 6 months, Ultra-Short Duration Funds are a good option.
- If you have a time horizon of 6 months to 1 year, Money Market funds could be a good choice.
- If the investment horizon is between 1 year and 3 years, you can consider investing in Corporate Bond Funds, Banking & PSU Bond Funds, or Short Duration Bond Funds.
It’s important to choose the fund that aligns with your investment goals, risk appetite, and investment horizon.
Debt funds have the potential to offer higher returns than fixed deposits, but they also carry some risk. However, the returns from debt funds are not fixed and can vary based on market conditions.
Yes, inflation can affect the returns generated by debt funds as it can reduce the real value of the returns. It’s important to consider inflation while selecting debt funds for investment.
Debt funds generate returns through interest income and capital appreciation. The returns are dependent on factors such as interest rates, credit ratings of the underlying securities, and other market conditions.
Yes, debt funds can generate regular income in the form of interest and dividend.
Yes, you can invest in debt funds through SIP (Systematic Investment Plan). SIP allows you to invest a fixed amount at regular intervals, such as monthly, quarterly, or annually.
Debt funds are not risk-free, but they are relatively low-risk compared to equity funds. The risk associated with debt funds depends on the credit rating of the underlying assets. Debt funds carry mainly credit risk and interest rate risk.
Yes, debt funds are highly liquid, and you can redeem your investment anytime. However, it’s important to note that some funds may have an exit load if you redeem your investment before a certain period.