What are Debt Mutual Funds?

Debt mutual funds are investment schemes that allocate their assets into fixed-income instruments. These include corporate and government bonds, corporate debt securities, and money market instruments.
What are Debt Mutual Funds?
3 mins
17 Feb 2024

If you are an investor who is exploring investment options that balance capital appreciation with stability, you’re going to love Debt Mutual Funds. Debit mutual funds are investment schemes that channel your money into fixed-income instruments like corporate and government bonds, corporate debt securities, and money market instruments. Due to this, they are also known as Fixed Income Funds or Bond Funds. Debt mutual funds are an excellent choice for those seeking a steady and relatively low-risk investment avenue. In this blog, we'll look into debt mutual funds in-depth understanding, how they work, and why they might be the perfect addition to your investment portfolio.

On the Bajaj Finserv platform, we have over 15 categories of debt funds depending on their maturity period. Invest in debt funds to get stable returns and diversify your investment portfolio.

The following sections of this blog will cover important details related to these funds.

What is a debt mutual fund?

Debt funds allocate investments into assets that provide predictable income, such as treasury bills, corporate bonds, commercial papers, government securities, and various money market instruments. These instruments feature predetermined maturity dates and interest rates, guaranteeing investors fixed returns upon maturity, hence earning the label of fixed-income securities. Due to their stability, returns from these assets are typically unaffected by market fluctuations, rendering debt securities as favorable options for low-risk investments.

How do debt funds work?

The fund manager of debt funds purchases listed or unlisted debt securities at a particular price. Then, he/she sells them later at a margin, which increases or decreases the fund’s value.

The underlying debt instruments in which the scheme invests also generate periodic interest. There are certain schemes, which earn more interest from fixed-income instruments during the fund's tenure. Interest income gets added to a debt scheme daily.

The Net Asset Value (NAV) of a debt scheme depends on the interest rates of underlying assets. It also depends on the upgradation or gradation of the credit ratings of a fund's holdings. Another factor affecting a debt fund's returns is interest rate movements.

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Frequently asked questions

Which is better FD or debt mutual fund?

Debt funds can be a fantastic tax-saving investment choice for a number of reasons, even in light of recent developments that seem to indicate they are now on par with fixed deposits.

For example, debt mutual funds are only taxable upon sale of the investments, unlike fixed deposits.
You could have to pay the early withdrawal penalty if you choose ordinary FDs. On the other hand, after a given time, debt funds don't impose any departure loads.

Also, generally debt funds offer better returns but are dependent on the performance of the underlying assets and can fluctuate based on changes in interest rates and other economic factors.

Are debt funds tax free?

Changes made to the Budget 2023 suggest that a Specified Mutual Fund will no longer benefit from indexation when calculating long-term capital gains (LTCG). Debt mutual funds will thereafter be subject to taxation at the appropriate slab rates.

Are debt funds risky?

Debt funds are considered low-risk investments because you are essentially lending money. However, there are some risks to keep in mind. They are:

  • The interest rate risk- Bond value is connected to the interest rate. So when interest rates rise, bond prices fall and vice versa
  • Inflation risk- Bonds provide fixed returns at regular intervals. But if the rate of inflation grows faster than the fixed amount of income, the investor’s money is devaluing.
  • Credit risk- There is always the risk with any lending, that the borrower defaults. In debt funds this is rare, but possible
What is a debt fund?

A debt fund is a type of mutual fund that predominantly invests in fixed-income securities like bonds and debentures.

Is it good to invest in debt funds?

Investing in debt funds can be a good choice for those seeking regular income and capital preservation. They are generally considered lower risk than equity funds.

Is it good to invest in a short-term debt fund?

Short-term debt funds can be a good option for investors with a lower risk appetite and a shorter investment horizon. They are less exposed to interest rate fluctuations compared to long-term debt funds.

How do I choose a debt fund?

When choosing a debt fund, consider factors like your investment horizon, risk tolerance, and the fund's credit quality and portfolio duration.

Do debt funds have a lock-in period?

Most debt funds do not have a lock-in period, which means you can redeem your investments at any time without any restrictions. However, some funds may have an exit load for redemptions made within a certain period.

Is debt fund under 80C?

Debt mutual funds are not covered under 80C of the Income Tax Act, of 1961.

What is the holding period of a debt fund?

It is advisable to hold a debt mutual fund for a minimum of 3 years as it will help average out your capital gains taxes.

When to exit debt mutual funds?

There are no criteria for the exit of debt mutual funds. It is specific to every investor's needs and preferences. However, since Debt Mutual Funds are taxed under capital gains, it is advisable to exit debt mutual funds after 3 years.

What is the new rule for debt mutual funds?

The new taxation rule, which is in effect from 1st April 2023, has taken away the benefit of indexation on maturity of debt mutual funds.

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Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.