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Debt Funds – Meaning, Types & its Advantages

debt fund

In this article, we will first answer the question, what is debt fund. After understanding the meaning of debt mutual funds,we will look at the type of debt funds and the benefits of debt funds.

What is debt fund?

Debt funds are mutual funds that invest in fixed income instruments like treasury bills, government securities, money market instruments, and so on. Debt mutual funds are less volatile and hence less risky than equity mutual funds.

Types of debt funds

Now that we have seenwhat is debt fund andhave an idea about the meaning of debt funds, we will take a look at the different types of debt funds in India.

Income Funds:

Income funds mostly invest in securities which have different maturity periods so that they can take advantage of interest rate movements. Such funds are ideal for investors who have a longer time horizon and a higher risk-taking ability.

Dynamic bond funds:

Dynamic bonds funds are actively managed debt funds. The fund manager keeps changing the investment portfolio based on a changing interest regime and in the process, tries to maximise returns.

Liquid funds:

These debt funds are funds that invest in debt instruments with a maturity period of a maximum of 91 days. Liquid funds can be redeemed almost instantly. They give a higher rate of return than a savings account and provide the same level of liquidity.

Credit Opportunity funds:

These debt funds try to generate higher returns by holding lower-rated instruments, which come with higher interest rates with the hope that they will deliver high returns. They are thus riskier than other debt funds.

Short-term and ultra-short term debt funds:

These funds invest in instruments which have shorter maturities, which could range from 1 to 3 years. Since these funds are not affected by interest rate movements, they are meant for conservative investors.

Gilt funds:

Gilt funds are another type of debt funds in India that invest in government securities of varying maturities. These are very highly rated and carry a relatively low level of default risk. However, gilt funds carry interest rate risk, and the NAV of the fund falls sharply when interest rates go up.

Fixed Maturity Plans:

Fixed maturity funds will have a fixed period for which your money will be locked in, which could be in months or years. Investment in these debt mutual funds can be made only during the initial period. However,returns from fixed maturity plans are not guaranteed.

How to invest in debt funds:

You can choose both SIP or lumpsum amount to invest in a debt fund. Unlike equity funds, investing through SIPs in a debt fund does not have the benefits that come with investing in SIPs as debt funds are less volatile. However,investing through SIPs helps bring discipline to your investments. But when investing in SIPS, one should remember that an investor has to hold a fund for three years to be eligible for tax benefits.

Debt fund schemes come with various benefits.

Less risk:

Debt funds are not affected by market risks and hence provide stable returns irrespective of the market conditions. They have the potential to offer steady returns with less volatility and are meant for risk-averse investors.

Higher returns:

Debt funds have the potential to generate higher returns than other investments in the fixed income space. The pre-tax profits on debt funds are comparable with other fixed income options like bonds and fixed deposits. In the case of long term debt funds, an investor can make substantial capital gains if interest rates fall.

Tax benefits:

Gains on debt mutual funds held for less than 36 months are taxed under short term capital gains and taxed per as the income slab of the investor. However, when held for more than 36 months, it is treated as long term capital gains and taxed at the rate of 20 per cent after indexation, which is a method to factor in inflation.

High liquidity:

Debt funds, especially liquid funds, come with a high level of liquidity and investors can redeem their investments much faster than comparable investment options.

Flexibility:

Debt funds are flexible because you can invest some money in it in the way of SIPs when you have surplus cash or in a lumpsum. You can also choose the between dividend and growth options based on whether you need regular income or want to create wealth. Also, you can shift the money from a debt fund to an equity fund of the same fund house as and when you want.

Due to the above benefits, you should consider including debt funds in your portfolio.

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