How To Invest In Debt Funds?

How To Invest In Debt Funds?

Debt mutual funds are often seen as a good alternative to bank savings accounts and fixed deposits. Here’s a detailed guide that will help you learn everything you need to know about debt funds and how they will be a good option for your investment portfolio.

What Are Debt Mutual Funds?

Debt mutual funds are mutual fund schemes that invest predominantly in fixed income-generating securities like Commercial Papers (CP), Certificates of Deposit (CD), Corporate Bonds, T-Bills, government securities, and other money market instruments. These instruments have a fixed maturity date and interest rate, which the buyers could earn until the maturity of the security. Debt mutual funds are considered to be less volatile than equity funds.

There are different types of debt funds and they are Overnight Fund, Liquid Fund, Ultra-Short Duration Fund, Money Market Fund, Short-Duration Fund, Medium Duration Fund, Corporate Bond Fund, Credit Risk Fund, Banking & PSU (Public Sector Undertaking) Fund, Dynamic Bond Fund, Gilt Funds, Fixed Maturity Plans. 

Who Should Opt For Debt Mutual Funds?

Debt mutual funds are suitable for those investors who are looking to invest in funds that have moderate risk. Debt funds carry a lower risk than equity funds. 

They are also a good investment option if you have surplus funds. Debt funds are also a good way to reduce the overall risk in your investment portfolio. 

Types Of Debt Mutual Funds

There are different types of debt mutual funds that are available for investors to choose from. The features of these low-risk funds differ according to their type.

Overnight Fund

This mutual fund invests in those securities that have a maturity period of 1 day. These funds carry minimal credit risk and interest rate risk due to the short maturity period. Therefore, overnight funds are said to be relatively stable.

Liquid Fund

This mutual fund invests in debt and money market securities with a maturity period of not more than 91 days. Investors can withdraw up to ₹50,000 as an instant redemption facility from some liquid funds. 

Ultra-Short Duration Fund

This fund invests in debt securities and money market instruments such that the *Macaulay Duration of the portfolio is between 3 to 6 months.

*Macaulay Duration – It is the length of time taken by the investor to recover his invested money in the bond through coupons and principal repayment. This length of time is the weighted average of the period the investor should remain invested in the security to have the present value of the cash flows from the investment match the amount paid off the bond.

Money Market Fund

This debt mutual fund invests in money market securities with a maximum maturity of 1 year. 

Short Duration Fund

This mutual fund invests in debt securities and money market instruments such that the Macaulay Duration of the portfolio is between 1 to 3 years.

Medium Duration Fund

This debt mutual fund invests in debt securities and money market instruments such that the Macaulay Duration of the portfolio is between 3 to 4 years.

Corporate Bond Fund

This fund invests predominantly invests in corporate bonds rated AA+ and above.

Credit Risk Fund

This debt mutual fund predominantly invests in papers rated AA and below (excluding AA+ rated corporate bonds). This fund invests in papers that offer relatively higher interest rates. On the other hand, these funds carry credit risk compared to other debt funds.

Banking & PSU (Public Sector Undertaking) Fund

This debt mutual fund invests at least 80% of its assets in debt and money market securities of Banks, PSU, Public Financial Institutions, and Municipal Bodies.

Dynamic Bond Fund

These funds invest in debt instruments that have shorter (1 to 3 years) as well as longer (3 to 5 years maturities). The fund manager will change the portfolio depending upon their forecast on interest rates. If the forecast is for increasing interest rates, the maturity is shorter and if the forecast is for falling interest rates, the maturity is longer. These funds are slightly riskier than short-term debt funds.

Gilt Funds

These debt funds invest at least 80% of their assets in government securities with varying maturities. These funds have exposure to sovereign papers, which carry very little credit risk. Hence, they are considered relatively stable investments.

Fixed Maturity Plans

FMPs come with a lock-in period, which can differ based on the scheme you choose. You can invest in FMPs only during the initial offer period, and post that, you cannot make further investments in this scheme. FMPs are compared to FDs often as they come with a lock-in period. However, FMPs don’t promise fixed returns, unlike FDs. But, FMPs are more tax-efficient than FDs.

Characteristics Of Debt Mutual Funds

Average Maturity – The average maturity of debt funds differs based on the fund category. Thus, the maturity profile of the underlying securities of the debt fund portfolio can be a combination of both short and long-term instruments based on the fund’s underlying objective.

Returns – The returns from other debt funds may fluctuate less to more depending on portfolio maturity, changes in interest rates, and the credit profile of the investment portfolio.

Taxation – If you redeem your investments within three years from the date of purchase, you would have to pay the short-term capital gain tax. If you redeem your investments after three years from the date of purchase, you would have to pay long-term capital gains tax. The short-term capital gain is taxable as per the individual’s regular tax slab while the long-term capital gain is taxable at 20% with indexation benefits. 

Liquidity – When you redeem your investments from other debt funds, the redemption proceeds will take some time to hit your account, usually T+2 or T+3 days (T – Transaction Day). 

NAV Calculation – For debt mutual funds, the NAV is calculated only on business days.

Benefits Of Investing In Debt Mutual Funds

Diversification – When you invest a certain portion of your assets in debt funds, it will help protect your portfolio from the volatility of equity investments.

Risk Management – Investments in debt funds lower the risk of losses as they are less volatile as compared to stocks and equity mutual funds. 

Opportunity To Earn Regular Income – Debt mutual funds help in generating regular income through a dividend distribution. Depending upon the type of debt fund, you can get dividends daily, weekly, fortnightly, monthly, semi-annually, or annually. 

Advantage Of Interest Rates – If an investor selects the right type of fund that is suitable for his risk appetite and investment horizon, they may be able to generate income in line with the prevailing rates of interest. 

Opportunity To Park Surplus Funds – Equity mutual funds have proven to be very volatile in the short term. However, debt funds offer the opportunity to retail investors to park their surplus for a short while and earn good returns on them.

In The End…

Compared to equity mutual funds, debt funds come with limited exposure to market risk. Since there are several types of debt funds, you can choose one that suits your goals and investment horizon. You can choose to invest in debt funds via both the lumpsum and SIP mode through Koshex. All you need to do is create an account with Koshex and start investing in less than 3 minutes.

If you are wondering how much you will accumulate in a few years by investing in these debt mutual funds, there is no need for manual calculations as we have created super-efficient calculators just for you. These SIP and lumpsum calculators will let you know how much you will accumulate by investing a certain amount of money every month. The calculators will also tell you how much you need to invest every month to accumulate a certain amount. 

When you invest in Koshex, you can do more than just invest and withdraw. You can manage all your investments from your dashboard. Koshex is a one-stop solution for all your financial needs, as our platform will help you save and invest better, as well as, manage your overall finances in a smart way. You can get access to all this and more if you create an account with us and it will take less than a minute to do so. Head over to Koshex right away!