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A Beginner's Guide To Debt Mutual Funds

A beginner's guide to debt mutual funds.

What are debt funds?

A Debt fund is a type of mutual funds that invests in fixed return financial instruments such as corporate bonds, debentures, certificate of deposits, and government securities.

Since the investments Debt Mutual funds make have more predictable returns, they are considered low risk.

What are the different types of debt funds?

Debt Funds come in multiple flavours but these four kinds are most common

  1. General Debt Funds: The equivalent of vanilla flavour, your average mutual fund that invests in various types of debt instruments, both government as well as private, and of varying duration. These instruments normally take the form of Bonds, Certificate of Deposits, and Debentures.
  2. Monthly Income Plans: These are simply debt mutual funds that give out regular pay-outs in the form of pidends. The pidends can be given out monthly, quarterly, semi-annually or annually. These funds normally invest majority of their money in debt instruments with a minor portion invested in equity. Please note that while called monthly income plans, these are not like the post office monthly income schemes. Dividends are paid at the discretion of the fund and can be skipped.
  3. Gilt Funds: A type of debt mutual fund that invests only in long-term government securities, such as government bonds. While they may seem like the safest kind of debt funds, their returns can vary a lot (for an average gilt fund - 2.5% in 6 months, 16% in a year, 9 % in 5 years) and thus not recommended for common investors.
  4. Liquid funds: These are debt mutual funds that invest in short-term debt instruments such as a certificate of deposits, treasury bills, term deposits etc. The maturity period of these instruments is normally in the range of 3 months to 6 months.

What kind of returns can I expect by investing in Debt Funds?

Debt Funds in general, provide returns at par with inflation and similar to Bank Fixed Deposits. For the last few years, these returns have been in the range of 7-9 percent. Just as all Bank FDs don’t have the same rate of interest, return on various debt funds also varies. Do keep in mind that, the returns are not guaranteed or committed up front.

How will investing in debt funds help me?

Here’s how Debt Funds can help you:

  1. A great alternative to fixed deposits, especially if you pay taxes on your income. Higher your tax slab, more benefit you can get. Unlike FDs, debt mutual funds will at least match inflation after tax.
  2. Good for goals that are critical, time-bound, and non-negotiable.
  3. They complement equity mutual funds in your portfolio and bring stability especially during market volatility.
  4. Use debt mutual funds for short duration investing.

In part 2 of this series, we will show you how Debt Mutual funds help with tax efficiency and is there something like a good time to invest in debt funds?

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