What are Debt Funds and Who should invest in them

What are Debt Funds and Who should invest in them: Do you have any plan to invest in the debt funds in the near future? Do you have any queries related to debt funds? If yes, then you have reached the right place. Here, we will provide you all the basic information about debt funds such as what are debt funds, benefits of debt funds, types of debt funds and who should invest in debt funds.

What are Debt Funds?

What are Debt Funds and who should invest in them

Debt Funds are mainly a mixture of income earning investments like Government Securities, Corporate Bonds, Treasury Bills, Corporate Deposits, various money market instruments and debt securities of various measures.

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The main difference between Equity and Debt Funds is whenever you buy any equity instrument like stock, you buy Ownership in that specific company and help in increasing its growth. However, in a case of Debt Funds, whenever you buy a debt instrument, you give a loan to that issuing entity. In return, all the government, as well as private companies issues, generate bills and bonds to continue their operations. The interest you gain from debt funds is pre-decided in advance, after which it will be closed.

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Benefits of investing Debt Mutual Funds

Following are the main benefits of Debt Mutual Funds:

1. Time Horizon: When one thinks of investing in debt funds, one doesn’t have to worry about the Time Horizon. If you are thinking of investing for 3 months, then there are liquid Funds. These funds can be considered as a good choice when we compare with savings bank account. Also, they provide high liquidity and stable funds.

If you want to invest for a period of 3 months to 1 year, then they are called Ultra-short term bond funds. Also here, one can invest for a short term of 1-2 years, the medium term of 2-3 years and a long term of 3-5 years. In all the above terms, returns, as well as risks, increase as you invest for long term.

2. Tax Efficient: This is the main benefit of Debt Funds. In Traditional assured return products, interest income is taxed every year at income tax slab rates. However, in the case of debt funds, only a change in asset value is being taxed. In Debt funds, one has to pay short term capital gains if units are held of less than 3 years.

In debt funds, investors mainly benefit from long-term capital gains tax at 20% and only if a component of gain exceeds inflation. For Example, if you earn 8% per annum for over a period of 3 years and the inflation rate is 4%, you just need to pay tax on the incremental returns of 4%. This is known as Indexation and is mainly calculated using the cost inflation Index.

3. Regular Cash Flows: Day by day interest rates are decreasing and life expectancy is increasing. Due to this, there is a fear that retirees may run out of retirement corpus. In Debt mutual funds, you can achieve good cash flows using Systematic Withdrawal plans. For Example, if you invest Rs 25 lakh in a bank with a deposit paying 9% interest per annum. Hence, you will get about Rs 18,750 per year.

In this case, if you are coming under the highest tax slab of 30%, then you have to pay about Rs 5,600 as a tax on the total interest received and your final net income becomes Rs 13,100.

But, if you choose to invest in SWP with a monthly investment of Rs 18,750, you have to just pay a fraction of tax thus generating highest tax returns.

4. Diversification: Debt Funds helps you to make more diversified portfolio as they provide more returns as compared to equity funds. Hence, Diversifying in the debt funds decreases the overall portfolio risk.

5. Flexibility: Debt funds provide more flexibility than fixed deposits. One of the major benefits of debt funds is, one can withdraw the money every month, which is very much beneficial for retired people. Also, one can shift the money from a debt fund into an equity fund or any other scheme.

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Now:

Types of Debt Funds

Dynamic Bond Funds

These types of funds are not fixed for a particular maturity period. Dynamic Mutual Funds have a varying maturity period as these funds interest call rates and invest in instruments with short as well as long maturities.

Income Funds

Income Funds you can invest in a scheme with across different debt instruments such as bonds, government securities, etc. These are more stable as compare to Dynamic Funds. Here, one can invest for short term of 1-2 years up to a long term of 15-20 years.

Gilt Funds

Gilt Funds mainly invest in the Government Securities. As they are owned by the Government, they don’t have any risk. However, these funds have high-interest rate risk. Also, these funds lose some part of the net asset value (NAV) due to any changes in the interest rates.

Liquid Funds

All the investors who are planning to invest for about 3 months, then liquid funds are the best. Liquid Funds invest in the debt instruments with a maturity period of about 91 days. Various liquid money market instruments include treasury bills, commercial papers, Commercial deposits, etc. The returns obtained using liquid funds are more comfortable. Also, liquid funds are a nice substitute of a savings account as it provides similar liquidity and higher returns.

Short term funds

This is a very good investment option for all the investors who want to invest for just 3-6 months. These funds mainly invest in the short term papers such as Commercial papers, and certificate of deposit.

Credit Maturity Funds

These funds have recently been introduced. As compared to all the other debt funds, Credit Maturity Funds doesn’t invest as per the maturities of debt instruments. These funds focus on getting higher returns by taking a call on credit risks. These bonds seek to hold low rated bonds that arrive with high rated risks. These funds hold more risk.

Fixed Maturity Plans

These are also known as closed-end funds. These funds invest in fixed income securities like corporate bonds and government securities, which comes with a fixed tenure. All the FMPs have a fixed tenure in which money will be locked-in. This tenure can range from months to years. In FMPs, there is no interest rate risk. Here, FMPs can provide higher returns but there is no guarantee.

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Bottom Line:

How to Select Debt Mutual Funds?

One should select the Debt Mutual Funds, based on two main aspects. One is Investment Horizon and the other one is matching scheme for Investment.

Last but not the least:

Who should invest in Debt Funds?

Debt Mutual funds are very much beneficial to the regular investors. They are also considered as an alternative to fixed deposits. Debt Funds generate returns and are in the range of fixed deposit interest rates, while they are more efficient as compared to fixed deposits.

In Fixed deposit, the interest earned is added to your income and taxed as per your slab. While short-term gains which are obtained from the debt funds are also added into the investor’s taxable income. Here, they become tax efficient when the holding period is more than 3 years. Here, long term gains are taxed at 20% indexation.

Debt Funds are also known as liquid funds. As we know, fixed deposit comes with a fixed tenure, debt funds can easily be closed anytime or can be shifted to any other funds.

One of the main point to remember is, debt funds don’t provide a full guarantee of returns such as fixed deposits.

We hope that you got all the essential information about debt funds. If you liked this article, then please share it with your family and friends.

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