What are debt funds? They invest in money market instruments like government bonds, corporate bonds, commercial paper and treasury bills. The main reason to invest in these funds is to generate a steady interest income and appreciate capital. Both the interest rate and the maturity period are pre-determined by the issuers of debt instruments. Therefore, these are also called fixed-income securities.


How do Debt Mutual Funds Work?

Debt funds invest in various securities depending on their credit ratings. The rating shows the risk of default in dispensing the returns promised by the issuer. Therefore, the fund manager makes sure to invest in high-rated instruments. The higher the credit rating, the more is the entity's likelihood to pay regular interest on the security and repay the principal on maturity.

Debt mutual funds that invest in higher-rated securities have lower volatility. Maturity varies with the fund manager's investment strategy and the average interest rate in the economy. If the interest rate regime goes down, the fund manager usually invests in long-term securities and vice-versa.

Who Can Invest in Debt Funds?

Debt mutual funds try to grow returns through investments across various classes of securities. But the returns can't be guaranteed. They generally fall in a predictable range. So, these funds are safer avenues for investors with a low risk appetite and medium-term (3-5 years) and short-term (3 months to 1 year) investment horizons.

  • Medium-term debt funds: For a medium-term investment horizon, dynamic bond funds are helpful to ride the interest rate volatility. Over a 5-year term, debt funds offer higher returns than bank FDs. If you want to generate a regular income, consider choosing monthly income plans.
  • Short-term debt funds: For short-term investors, liquid funds are better than savings bank accounts. These funds offer greater returns (7% to 9%) and similar kinds of liquidity to help finance emergency requirements.

What are the Types of Debt Funds?

  • Liquid Funds: As the name suggests, they invest in liquid instruments. These have a maturity of 91 days and therefore, are suitable for short-term investors.
  • Dynamic Bond Funds: They invest in debt instruments that come with varying maturity periods. These funds are ideal for investors who have a moderate risk appetite.
  • Short Duration Funds: They invest in debt securities where the scheme's duration ranges from 1 to 3 years.
  • Long Duration Funds: They invest in debt securities where the scheme's duration is over 7 years.
  • Gilt Funds: They invest primarily in high-rated government securities that do not come with any kind of credit risk.
  • Credit Opportunity Funds: They invest in low-rated securities where the possibility to gain better returns rises with the risk that the investor is willing to take.

You can invest in debt funds in India if you tend to avoid taking much risk. This is because these funds invest in securities that offer interest at a predetermined rate. Also, the principal amount that you originally invested is returned in full upon maturity. Now that you know what debt funds are, choose a reputed fund house to start your investment journey.