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What are Debt Funds?

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 favorable investment options because they attempt to deliver stable and low-risk returns that are better than other comparable options like fixed deposits.

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 to ensure investment objective is met?

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 investment plans 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 in a mutual fund scheme, 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? Are you only looking for mutual funds investment along with tax planning options?

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 and set your investment objective 

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.

Learn Mutual Funds Risk

What is the Meaning of a Debt Mutual Fund?

best 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 government securities such as stocks, bonds, fixed income earning securities, and other asset classes.

Debt fund invests in fixed income funds such as government securities and 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, money market instruments debt is typically borrowed to meet existing financial obligations or to make money available for future expenses. index funds

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. money market instruments

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. money market instruments When the bond matures, the investor receives the principal along with the promised interest. index funds

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. This is how debt fund invests. index funds

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 an equity mutual fund scheme, you always have a fair idea about what your mutual fund’s 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 risk ratings of debt instruments available in the market. A good credit risk 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.

Debt instruments with a credit rating of AAA are 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? 

reliance regular savings fund debt

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 setting up an investment objective
  • 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 your investment 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. The 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

The 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 efficient to save tax. However, the benefit of LTCG is no longer available for investments from April 1st 2023, this is as per the Finance Bill 2023. Also, TDS is not applicable to debt funds.

Having a better understanding of debt funds is really important whereas debt funds have added excellent value for investors over the past 20 years.

Difference between Debt Funds and Equity Funds

debt funds india

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 three broad categories: debt funds, hybrid fund, 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, treasury bills. 

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 different risk and higher risk profile but compensate with higher returns.

Debt funds have largely predictable returns, whereas, the return on equity funds vastly depends.

Whereas hybrid fund invest in both equity and debt providing diversification among 2 or more asset classes. These are also known as asset allocation funds. Asset allocation can be used for many purposes. With hybrid fund an investor has an option to invest in different asset classes through a single fund. 

Learn Equity Funds vs Debt Funds

Difference between Debt Funds and Fixed Deposits

Fixed deposits are the most popular form of investment 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 investments in 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 investments in fixed deposits is taxed as per the income tax slab applicable to you.

Different Types of Debt Mutual Funds

types of debt mutual funds

There are different type of debt funds available in the market today. There are plenty of options for investors with varied preferences. Some of the most popular type 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 amoderate 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 short term funds and ultra short term funds ranges from 1 year up to 3 years.

Ultra short term funds lend to companies for a period ranging from 3 to 6 months. Due to the low lending duration they are slightly riskier than liquid funds but still one of the low risk category funds when compared to other funds of the same category

We have a detailed guide on short term funds to help you better understand these debt mutual funds

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 but volatile 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.

ICICI Pru Liquid Fund (Growth)

Scripbox recommends ICICI Pru Liquid Fund (Growth) for investment within the liquid-debt mutual fund category. The fund has also maintained a higher-than-average level of return predictability, while also ensuring the market determined risk is lowest among its category peers. In our view, the credit quality of the underlying holdings (current and historical) is better than the category average. With a past performance of 17 years, the fund has an extended history for analysis and the track record is excellent. With an AUM or relative size of Rs 34,602.577 cr, the scheme is the leader within the category of the liquid mutual fund.

HDFC Overnight Fund(G)

Scripbox recommends HDFC Overnight Fund (Growth) for investment within the liquid-debt mutual fund category. The fund has the lowest market determined risk (Liquidity risk & Credit risk), as measured by the YTM’s standard deviation. The 3-year daily rolling returns over the last five years is 4.74%, which is among the best in the category. Overall, the fund manager has ensured safety, without overtly compromising on returns. With a past performance of 20 years, the fund has an extended history for analysis and the track record is excellent. With an AUM or relative size of Rs 12,085.262 cr, the scheme is the leader within the category of the overnight mutual fund.

HDFC Floating Rate Debt Fund(G)

Launched in 2007, the fund has the highest average assets under the management of Rs. 14,559 crores, among its category peers. The fund has consistently delivered above-average 3 years rolling returns of 7.79% with the best level of return predictability. In our view, the fund has the lowest market determined risk as well. All these elements are put together to make this fund a “Scripbox Recommended Fund” within the floating rate category.  With a past record of 15 years, the fund has a sufficient history for analysis and the track record is good. The fund has a higher credit quality in comparison to other debt funds. The scheme is moderately impacted by interest rate fluctuations.

Aditya Birla SL Savings Fund-Reg(G)

Launched in 2001, the fund in terms of average assets under management at Rs. 16,987 crore, beats the rest of its category peers by a wide margin. The fund’s 3 year rolling returns for the last five years is 7.28%, which is among the top among its peers. The fund has consistently remained in the top quartile over multiple periods. Though the credit quality of the instruments is below average, the issuers are relatively strong. The market determined risk and the deviation in credit quality is one the lowest in the category. Owing to the AUM of Rs 14,667.698 cr the scheme is a leader in terms of the relative size of the scheme within its category

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).

Short term capital gain is taxed as per the income tax slab of the investor and long term capital fund is taxed at 20% after indexation.

From April 1st 2023, investments in debt funds will no longer have the indexation benefit. The capital gains will be taxable as per the investor’s income tax slab rate, irrespective of the holding period.

You can use Scripbox’s income tax calculator and do a tax planning to estimate the tax on returns and save tax

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 you will see a bright green clickable button that says, ‘Let’s Get Started’.

invest in mutual funds

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

begin your investment journey

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’

start growing wealth

You can select if you would like to make monthly (SIP) payments or a One Time investment plans. You can mention the 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.

long term wealth

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

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

invest with scripbox

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 objective

If borrowing gets excessive, it could snowball into a debt trap. That’s why it is important to keep your debt under control by separating the good from the bad ones.

Do you know what makes debt fund price goes up Or down?

Scripbox has suggested the best debt funds in India 2019.

Here are the steps you need to take to get out of the debt trap.


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. Before investing it is always wiser to estimate the return on investment and the tax payable on the returns. You can use Scripbox’s income tax calculator to get an estimate of tax payable. Once you feel ready, you can start investing. 

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

You may also like to read about the Liquid Fund vs Debt Fund

Explore our article on Liquidity Trap