What are Debt Mutual Funds

Learn more about debt mutual funds, their types and why should one invest in them.
Debt Mutual Funds
3 mins
17 Feb 2024

Debt mutual funds are those schemes that invest in fixed-income instruments like government bonds, corporate bonds, money market instruments, commercial papers, and other securities. These offer capital appreciation and regular interest incomes. Financial experts also call these bond funds and income funds.

While debt funds carry fewer risks when compared to equity funds, these funds also generate lower returns than equity mutual funds.

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.

Who should invest in a debt fund?

People with a low risk-taking capacity are the ideal investors of debt funds. These schemes suit the following investors:

  • Short-term investors
    People who have an investment horizon of 3 to 12 months can consider investing in debt funds. It is a much better option than keeping funds in a regular savings account. They can consider investing in liquid funds that offer returns of around from 6 to 7%, annually.
  • Medium-term investors
    People who have a medium-term investment horizon of 3 to 5 years can choose debt schemes. For such investors, dynamic bond funds are suitable as they generate higher returns than fixed deposits and short-term bond funds. If an individual wants monthly payouts, they can choose a monthly income plan.

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.

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