Debt funds: The basicsDebt-oriented mutual funds invest predominantly in fixed-interest instruments such as government securities, corporate bonds and other debt securities. Investments in debt funds generate a steady interest income (reason why they are referred to as fixed-income securities) coupled with capital appreciation.
The workings of a debt fundA debt fund invests across fixed-interest securities, based on their respective credit ratings. It is the fund manager’s prerogative to invest in instruments that have high credit ratings. With a quality credit rating, chances are the fund will continue to generate a fixed interest income on the debt security, along with the principal sum upon maturity.
Types of debt fundsDepending upon the investor’s financial objectives, debt-oriented mutual funds can be of different types – with the main differentiator being the maturity period of instruments. Some of the more common ones have been listed below:
1. Dynamic bond fundsAs the name suggests, these funds are dynamic in nature that alter allocations between long and short-term bonds to take advantage of the changing interest rate.
2.Short and Ultra short-term debt fundsThese debt-oriented funds invest in securities with a maturity period ranging from 1 to 3 years. Not being typically affected by interest rate fluctuations, these are more suited to risk-averse investors.
3.Liquid fundsLiquid debt-oriented funds invest in instruments that have a maturity period not exceeding 91 days. These funds are usually considered a better alternative to savings account deposits because of their ability to offer increased returns subject to a reduced degree of risk.
Points to consider before investing in debt funds
1. RiskInterest rate risks constitute the primary risk component of a debt fund. Moreover, the fund manager might end up investing in securities - with a lower credit rating - that have increased risks of default.
2. ReturnsWhile debt funds invest in fixed-income instruments, they don’t exactly guarantee returns.
The final wordShould you want to stay invested for a shorter haul (somewhere between 3 months and a year), liquid funds can be ideal. Conversely, short-term bond funds can be the preferred investment vehicle were you to have an investment horizon of 2-3 years.Generally, chances of earning increased returns improve with a longer investment horizon.
Also note that capital gains from debt funds are subject to taxes, depending upon the fund’s holding period, the time for which one stays invested in the fund. If you stay invested for 36 months or more, the gains made are termed as long-term capital gains. On the other hand, if you stay invested for less than 36 months, the gains made are known as short-term gains (STCG).
While LTCG are taxed at the rate of 20% (after having accounted for the effects of inflation), STCG will are added to your income and taxed according to applicable IT slabs.
Choose a mutual fund based on your life goal, risk appetite and duration for which you wish to remain invested.
Explore different Debt Funds here.
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
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