Debt fund mutual fund schemes invest in fixed income-producing assets such as Commercial Papers (CP), Certificates Of Deposit (CD), Corporate Bonds, Treasury Bills (T-Bills), Government Securities, and other money market instruments. These financial instruments have a set maturity date and interest rate that buyers can receive up to the security’s maturity. They are thought to be less erratic than equities funds, making them the perfect choice for those who are opposed to risk and seek consistency in their investments.

Evaluate Debt Funds

You can assess debt investments using the following criteria:

Portfolio: These include a list of the products the fund has invested in, providing information about its investment approach.

Maturity profile: Can be utilized to comprehend the portfolio’s structure.

Yield to maturity: A metric for the potential interest income a portfolio could generate. The current returns on your other, safer investments should be compared to this.

Credit rating: By examining the credit quality, it is possible to determine how susceptible the fund may be to credit risk. The probability of default increases with lower ratings.

Average portfolio maturity: Indicates the amount of time it will take for the bond’s principal to be repaid.

Duration of the portfolio: Can be looked at to determine how price sensitive it is to an environment with fluctuating interest rates. This may hint at the fund’s potential interest rate risk volatility.

Maturity and duration: A bond portfolio consists of various securities with various maturities. The weighted average of the remaining time before maturity is known as average maturity. In an environment where interest rates are falling, a fund with a larger maturity and duration can be anticipated to do well, and vice versa. Bond tenure affects a bond’s sensitivity to interest rate changes; asset values and interest rates are inversely correlated.

Taxation Benefits

Debt funds offer dividends and capital gains to investors. The difference between the price at which units were bought and the price at which they were reclaimed or sold is known as a capital gain.

The period an investor keeps mutual fund units affects how capital gains are taxed. If an investor holds a debt fund investment for up to three years, capital gains on redemption or sale are treated as short-term capital gains and are taxed at the investor’s applicable income tax slab rate.

The investor receives the benefit of “indexation” if the debt fund is sold or redeemed after already being held for more than three years.

Who should invest in debt funds?

Investors searching for Consistent Income: Risk-averse investors looking for consistent income, such as retirees, might consider debt funds that invest in high-quality bonds or keep durations short.

First-time mutual fund investors: As a substitute for bank fixed deposits, conservative or first-time mutual fund investors who do not wish to assume the risk of investing in equity funds may want to consider short-duration funds or corporate bond funds. The debt fund investment is anticipated to yield higher returns in addition to liquidity and withdrawal flexibility, mainly when interest rates are falling.

Investors seeking to buy stocks in a down-turning economy: Using a debt fund with an STP can be advantageous, even for a risk-taking equity investor (STP). In a sluggish or bearish market, for instance, an STP from a debt fund to an equity fund will reduce average cost since it will enable recurring transfers from the debt fund to buy equity fund units.

Investors looking to park short-term capital: Instead of keeping short-term surpluses in a bank account, households and businesses can invest them in liquid or ultra-short-duration funds. Even household emergency money can be controlled in an overnight or liquid fund while earning a little return. An FMP is an option for investors with a particular investment horizon.

Bottom Line

Debt funds are typically the last thing on investors’ minds when equities markets are at their highest. Investors usually aren’t aware that the greatest way to deal with the equity market’s volatility is to invest in debt funds. Debt funds can provide the advantages of capital appreciation and respectable returns over time if a careful decision is made among the many categories of debt funds while keeping in mind one’s total investment objectives.