“Debt” the word itself means loan. Debt funds invest in government and corporate fixed-income securities. These include Corporate Bond, Government Securities, Treasury Bills, Money Market Institutions and many other types of debt securities.
Investing in a company’s equity shares, It’s like a buying the stake for that company’s growth. However, when you buy a debt fund, you give a loan to the issuing entity. Government and private companies issue bills and bonds to get loans to run their various programs.
Debt Funds attract investment below three years and Long Term Capital Gains Tax for investment above three years.
Usually, In terms of returns Equity funds are much better than Debt funds, But they are more secure.
They are also known as ‘fixed income’ security because from the beginning the interest you receive and the maturity period is already known.
Examples Birla Sunlife Short-term fund, HDFC short-term fund, etc.
Debt Funds Pros and Cons
- Less Risky in: Debt funds are not dependent on stock market changes and hence are significantly less volatile and less risky.
- Diversification: Each debt fund invests in the number of fixed earnings securities and hence hedges the risk of default.
- No lock-in: An open-ended debt fund is very liquid so one can withdraw money as and when requires. There is no so lock-in.
- Better Returns: Few types of Debt Funds have provided a few percentage points better returns than other popular deposit schemes.
- Tax Efficient: Debt Funds are tax efficient in case of long term investment.
- Interest rate risk: Debt Funds carry interest rate risk and can add/reduce.
- No Control: Investors don’t have any control over investment, as fund manager manages them.
- Credit Risk: Some Debt fund manager take credit risk to get higher returns by buying bonds of small companies, which give a higher interest rate but have a higher chance of default.
- High Expense Risks: Some debt funds have an expense ratio of as high as 2.1% which is deducted from your total return. These expense ratios could be a high percentage of your yearly returns.
Types Of Debt Funds
Dynamic Bond Funds
As the name suggests, this ‘dynamic’ fund, which means that they change their portfolio according to the changing rate of interest. The maturity time of Dynamic Bond Funds varies because they keep investing in the short term or longer as per the interest rate.
Income funds also invest in various debt securities as per the interest rate, but most of them have maturity period long time. For this reason, they are more stable than dynamic funds. Their average maturity duration is approximately 5-6 years.
Short Term and Ultra Short Term Debt Funds
These are short term debt instruments, which are about 3 years old. Short-term debt funds are better for a general investor because they are not much affected by interest rates changes.
Liquid funds invest in debt instruments whose maturity period is not more than 91 days. Therefore, the risk is less in them. These negative returns are rarely seen.
These funds are a good option for Savings Bank account because they provide liquidity and large returns similar to them. Many mutual fund companies also offer the facility of quick withdrawal of liquid fund investments through special debit cards.
Gilt funds invest only in government securities. Government securities are more secured as it is launched by the Government. This is because the government sometimes gets defaulted in the loan taken as a debt instrument.
Credit Opportunity Funds (Credit Opportunities Funds)
These are new debt funds. Like other debt funds, credit opportunities do not invest in funds debt instruments. These funds earn more profits according to the credit risk. Low-rated bonds try to hold these funds to higher interest rates. These debt funds are risky.
Why invest in a debt fund?
This is a better option for a general and conservative investor. This fix is a good option for a deposit. Debt funds offer interest only in the area of fixed deposits, but they provide higher tax rebates than fixed deposits.
The income which comes from a fixed deposit is added to your income and you need to pay tax according to that slab. The short-term benefits of debt funds also add taxable income. But when the time period is more than 3 years then tax is more advantageous. 20% tax is levied after a long period of induction.
Debt funds are more liquid rather than fixed deposits. Where the capital is locked in a fixed deposit, debt funds can be withdrawn at any time. Removing some amount from the total amount is also possible in debt funds.
For all these analyses, Comparatively Debts funds are better. Nevertheless, it is important to keep in mind that like fixed deposits, there is no guarantee of capital protection or fixed return in debt funds.
Besides, don’t have any right but people who invest in debt funds get their amount first if the company may get shut down due to bankrupt or much other reason, in that case, debt funds holder gets their money first so we can say it’s secured fund.
As it provides interest rate better than Fixed deposit so it would be the best alternative of Fixed Deposit. Some debenture also converts into equity so Investors may have the option to convert their fund’s debentures to equity, So from conclusion we come to point that if we have loss risk appetizer then we can invest in debt funds.