Skip to main content
Scripbox Logo

All-in-one Guide to Best Debt Funds in India.

Debt funds are a great investment opportunity if you know what to look for and what kind of debt funds to invest in. Debts funds are seen as favourable investment options because they attempt to deliver stable and low-risk returns that are better than other comparable options like fixed deposits.
All-in-one Guide to Best Debt Funds in India.

Just about a year ago, you got your very first job. You were ecstatic when you received your very first paycheck. You felt empowered and limitless.

You could finally do all those things that you dreamt of when you were painstakingly trying to make-do with your monthly allowance. You could shop without asking for permission from your parents, you could eat at your favourite pizza joint more frequently and now you can finally buy a round of drinks for your friends that has been long due.

All this excitement wears off rather quickly when you realize that making money comes with a fair share of responsibilities. It’s great that you don’t have to ask anyone for money anymore, but you also have to pay your rent and your bills.

It doesn’t take you too long to get used to the idea that the finite nature of your income is constantly pitted against the growing need for expenses that come with time and lifestyle changes.

A few months into this brand-new, independent lifestyle, you realize that it is time to take matters seriously and start looking for ways to invest part of your income.

Now that you have made the decision to start investing, you have a host of questions that need answers.

Where do I invest?

What kind of investment should I start with?

Who should I talk to? And so on.

This is probably the right time to introduce you to what is a debt fund.

Debt funds are a great investment opportunity if you know what to look for and what kind of debt funds to invest in.

In this article, you will learn about the best debt funds in great detail and understand why they are one of the most suitable options to consider if you are just beginning your investment journey.

Let’s dive right in.

Fundamentals of Investing

Before we go further, we want to take a quick minute to talk about some fundamental principles of investing. Although this topic deserves an entire article dedicated to this discussion, it might be a good idea to briefly look at what they are.

“I want to make more money” is a common goal. Although that goal is a great one to have, it is important to dig a little deeper and add specifics to that statement.

For instance, why do you want to make more money? Wanting to live a comfortable lifestyle is a fair answer, but what entails a comfortable lifestyle requires a better understanding of your goals; specifically your financial goals.

Whenever you feel like you are ready to start investing, there are three things that you should primarily keep in mind.

1. Your financial goals - it is absolutely important to know what your financial goals are. Are you just looking for ways to make more money or do you want to invest and have enough money for things like purchasing a home? Do you have a plan to take care of your parents’ health emergencies? And so on. Take some time to think about all these questions. Feel free to add anything else that you may anticipate for the future.

2. Risk appetite - you need to have a very clear idea about the amount of risk you are willing to take with your investments. If you are just starting out, you might want to look at something with low or moderate risk. As you get better at understanding the world of investments, you can adjust your risk appetite accordingly. 

3. Investment horizon - this refers to the timeline in which you want to achieve your goals. If you plan on buying a home after 5 years, you will have to manage your investments in such a way that will enable you to make this happen in 5 years time. 

4. Have realistic expectations - this is the most important principle of investing. You need to have realistic expectations about your financial goals and be brutally honest about what you want to achieve.

What is A Debt Fund?

Now, what exactly is a debt fund?

Essentially, a debt fund is a type of mutual fund.

A mutual fund, as the name suggests, is a type of investment that pools money from different investors and invests the money in securities such as stocks, bonds, and other asset classes.

Debt funds are mutual funds that primarily invest in fixed-income securities such as government bonds, corporate bonds, treasury bills, commercial paper, certificate of deposit and other money market instruments.

Now, if that definition went over your head, don’t be overwhelmed. Let’s break it down and try to understand what it actually means.

All of us understand what debt is, right? Debt is nothing but money borrowed at a certain rate of interest for a certain period of time.

As you must already be aware, debt is typically borrowed to meet existing financial obligations or to make money available for future expenses.

Just like how individuals would require debt from time to time, like borrowing money to buy a car and so on, corporations and governments also borrow money for their existing and future financial needs.

Let’s take the example of a corporate bond. A corporate bond is issued by a corporation for the purpose of financing a variety of business requirements. These requirements include purchasing new equipment, expansion of business in a new market, investing in research and development, purchasing other suitable businesses and so on.

This means that the investors who buy corporate bonds are lending money to the company issuing the said bond. In return, the company makes a promise to pay interest for the duration of the bond. When the bond matures, the investor receives the principal along with the promised interest.

Similarly, a government bond is a debt security issued by the government to support any kind of government spending. Just like corporations, the government promises a periodic interest payment for the duration of the bond.

So, basically, debt mutual funds are a pool of such debt-based investment funds. A debt mutual fund purchases such bonds and passes on the interest that is earned from them to its investors.

We hope that helped you understand what debt funds actually are. 

How Does a Debt Fund Work?

Debts funds are seen as favourable investment options because they attempt to deliver stable and low-risk returns that are better than other comparable options like fixed deposits.

They are in a position to do this because they invest in market instruments, like the ones discussed above, that provide a fixed rate of returns.

Unlike equity funds, you always have a fair idea about what your investment in your chosen debt fund, will fetch you at the time of its maturity.

The debt fund manager decides which debt instruments will be purchased and managed under a particular fund. This decision is based on the credit ratings of debt instruments available in the market. A good credit rating indicates that the issuer of the debt instruments has a higher chance of making the interest payments on time and has the capacity to repay the principal on time and in full.

A higher credit rating means that the likelihood of payment default is very low. The rating assigned for different kinds of debt instruments are as follows: AAA, AA+, A, BBB, BB, B, C, and D.

A debt instrument with a credit rating of AAA is considered the safest with the least amount of risk and a debt instrument with a credit rating of C is considered to have a very high chance of defaulting on its financial obligations. If the rating is D, then, these debt instruments are already in default or are expected to default soon.

You know, just like the way we were graded in school.

Who Should Invest In A Debt Fund? 

If you are someone who fits into one of the categories described below, debt mutual funds might be an ideal investment option for you.

  • You are brand new to the world of investments and are not sure where to begin. 
  • You are looking for something that is short-term with a low-level of risk.
  • You are looking for something that provides a slightly better return than a savings bank account or a fixed deposit.
  • You want to invest in fixed income securities that have a predetermined interest rate with periodic interest payments.
  • You have a stable income and are looking for ways to supplement your monthly income.

Benefits of Investing In Debt Funds

Investing in debt mutual funds comes with a host of benefits. Some of the most important benefits are discussed below:

1. Independent of equity market: Debt mutual funds are not affected by the volatility of the stock market. Equity markets go through a lot of ups and downs, your investment in debt funds is not subject to this kind of uncertainty.

2. High degree of liquidity: Compared to most of the asset classes in the market today, debt funds offer a high degree of liquidity. You can withdraw money from your debt fund account easily at any time based on your requirements.

3. Flexible investment horizon: Investment horizon refers to the time in which you can achieve your financial goals. Debt mutual funds have a flexible investment horizon that can cater to any investment goal. This ranges from a time period that is as short as 3 months or can spread out over 3 years.

4. Better returns: this is probably one of the main reasons why debt mutual funds are a popular choice of investment for many investors. they offer a relatively stable return that is significantly better than other safe options such as savings account and fixed deposits.

5. Lower risk: debt funds are not risk-free like fixed deposits and neither are they extremely risky like the investments in equity markets. 

6. Tax-efficient: In the long-term, debt funds turn out to be very tax efficient. Also, TDS is not applicable to debt funds.

Difference between Debt Funds and Equity Funds

When you are just starting out, it is easy to get confused between different kinds of mutual funds. All of them might seem similar at first. There are many types of mutual funds in the market today. However, most of the funds fall under two broad categories: debt funds and equity funds.

There is a very important distinction between these two categories. As we have already learned, debt mutual funds invest in debt securities such as corporate bonds. Equity funds, on the other hand, predominantly invest in equity shares of different companies traded in the stock market.

For this reason, equity mutual funds have a different risk and higher risk profile but compensate with higher returns.

Debt funds have predictable returns, whereas, the return on equity funds is vastly dependent on market performance.

Difference between Debt Funds and Fixed Deposits

Fixed deposits are the most popular form of investments among many investors. That is understandable because they are safe, predictable and completely take the guesswork out of the equation.

Some of the main differences between debt mutual funds and fixed deposits are as follows:

  • Fixed deposits typically require a lump sum amount to be deposited at once while you can choose the option of SIP for debt mutual funds. 
  • The return on debt funds is higher than fixed deposits as debt funds are subject to higher risk compared to fixed deposits.
  • The fixed deposit might not allow withdrawal before maturity but you can withdraw money from your debt mutual fund account as per your requirement. 
  • Fixed deposits and debt funds are taxed very differently. The income from fixed deposits is taxed as per the income tax slab applicable to you.

Types of Debt Mutual Funds

There are different types of debt mutual funds available in the market today. There are plenty of options for investors with varied preferences. Some of the most popular types of debt funds are discussed here.

1. Dynamic Bond Funds - The fund manager of dynamic bond funds keeps changing the fund’s composition according to fluctuating interest rates. These are ideal for investors with moderate risk appetite and time horizon of 3-5 years. 

2. Income Funds - Income funds predominantly invest in debt securities with extended maturities. For this reason, they are more stable than dynamic bond funds. The average maturity period of income funds is about 5-6 years.

3. Liquid Funds - Liquid funds invest in debt securities with a maturity of up to 91 days. These funds are ideal for investors who wish to park some excess cash for a short period of time. Due to the short maturity period, they have the least amount of risk. They offer higher returns than a bank savings account.

4. Short-term and Ultra Short-term Debt Funds - These funds are particularly popular among new investors who want a short term investment with limited risk. The maturity period of these funds ranges from 1 year up to 3 years.

5. Credit Opportunities Fund - These funds are relatively risky in nature. Fund managers that manage credit opportunities fund undertake calculated risk by investing in lower-rated debt instruments in the anticipation of improved rating at a future date. They do this on the basis of market analysis and research. If they manage to get this right, they will be in a position to offer a higher return on investment for their investors.

6. Gilt Funds - These funds invest only in government-issued securities that are rated very well. Gilt funds provide a high rate of return with low credit risk.

7. Fixed Maturity Plans - Fixed maturity plans are very similar to fixed deposits. They are close-ended debt funds. They invest in fixed-income securities with a mandatory lock-in period. You can invest in these funds only during the initial offer period.

Top Performing Debt Funds

There are certain funds that have performed particularly well in the past decade. I wanted to mention a few of them here and include some information on how they are performed.

Tata Liquid Fund

As the name suggests, this fund falls under the category of liquid debt funds. Launched in September 2004, this fund continues to perform consistently. It is a good option for investors with a low-risk appetite as the fund primarily invests in certificate of deposit, commercial paper and treasury bills. This fund aims to generate reasonable returns with high liquidity. It has managed to generate a return of 7.37% over a period of one year and a return of 7.12% over a period of 3 years.

Kotak Savings Fund

Kotak savings fund was launched in August 2004 and falls under the category of ultra-short duration debt funds. This is a great option for investors looking to invest for a short term with better returns than bank accounts and fixed deposits. The risk level in this fund is moderately low as it is mostly invested in low risk debt securities. This fund has generated a return of 8.37% over a period of one year and a return of 7.41% over a period of 3 years.

ICICI Prudential Savings Fund

ICICI Prudential Savings Fund falls under the category of low-duration debt fund. It seeks to maximize short-term savings by investing in debt securities and maintaining a good balance between risk, liquidity and yield. This fund mostly invests in AAA, AA+ rated securities making it safe and moderately low risk option. It has an impressive track record of generating a return of 8.84% over a period of one year and a return of 7.76% over a period of 3 years.

Axis Liquid Fund

Axis Liquid Fund, again, as the name suggests falls under the category of liquid debt funds. It was launched in October 2009 and has proven to be a very reliable option over the past decade. It aims to provide a high level of liquidity with reasonable returns by investing in debt securities. Axis Liquid Fund has provided a return of 7.32% over a period of one year and a return of 7.08% over a period of 3 years.

Indexation and Taxes on Debt Mutual Funds

One of the biggest advantages of debt mutual funds is that the income generated from debt funds is subject to indexation. Indexation reduces your overall tax liability by adjusting the purchase price of the underlying debt instrument. This is done by factoring inflation and capital gains on your investment.

Capital gains on debt funds are taxable. The rate of taxation is based on how long you stay invested in a debt fund. A capital gain made under 3 years is called short-term capital gains (STCG) and a capital gain made over a period of 3 years or more is called long-term capital gain (LTCG).

STCG is taxed as per the income-tax slab of the investor and LTCG is taxed at 20% after indexation.

How to Invest in Debt Funds Online

You can get started with investing in debt mutual funds right away. In fact, it is so convenient that you can do it online.

Scripbox makes this particularly easy. All you have to do is create an account and start investing. 

When you head to scripbox.com you will see a bright green clickable button that says, ‘Let’s Get Started’.

When you click on that, you will see this on your screen.

You can click on the very first option that says ‘Start a SIP’

Once you do that you will need to fill in the following information and click on ‘Create A Plan’

You can select if you would like to make monthly (SIP) payments or a One Time investment. You can mention that amount you are willing to invest and the number of years you would like to stay invested.

For example, if you were to select monthly (SIP), put in the amount of Rs. 10,000 and say 6 years, this is what you will see.


You can then select if you would like a long-term or a short-term investment.

If you select short-term investment Scripbox will show you what is included in the basket of funds of the current year.

All you have to do is sign up with your email address and follow the instructions on your screen.

You can also talk to your relationship manager at your bank and take their help with both choosing a suitable debt fund and setting up your investment.

Conclusion

We hope this article provided you with all the information about debt mutual funds. 

Use what is mentioned here to do more research and continue learning about debt funds in India. Once you feel ready, you can start investing. 

Start small with whatever income you can spare and increase your investment whenever you can afford to do so. Good luck!