Like every other mutual fund category, debt funds too are gaining momentum among investors who are risk averse and do not want to expose their finances to volatile market conditions. Not just that, debt funds are also considered by those individuals who wish to diversify their equity heavy portfolio and give it the much needed liquidity.
Here are some of the basic details about debt mutual funds that all aspiring as well as existing investors must be aware of.
What are debt mutual funds?
A debt mutual fund is an open ended scheme that predominantly invests in debt related instruments and fixed income securities. Unlike equity funds that try to generate high returns, the primary objective of debt funds is to safeguard the investor’s capital and generate stable income. Not everyone has the risk appetite to invest in equity funds and such individuals can invest in debt funds that may generate anywhere between 8 percent to 10 percent average returns. However, these funds are not defined as debt funds are mutual funds and we all know for a fact that returns from mutual funds are subject to market risks.
Understanding how debt funds work
Debt funds work pretty much how borrowing and lending money works. Companies and governments that are in need of funds issue bonds for the exchange of funds. They prefer borrowing sum this way rather than approaching the bank. In exchange for the loan amount, they issue bonds that come with a maturity date. At the time of maturity, they return the loan amount along with the promised interest. Debt mutual funds invest in such bonds and other fixed income securities. Apart from government backed bonds and corporate securities, debt funds also invest in certificates of deposit, commercial paper, debentures, company fixed deposits, CBLO, reverse repo, cash, and cash equivalents, etc.
To invest in debt funds, you first need to understand the different schemes out there. As of now, there are 16 product categories under debt funds. These categories are listed by capital market regulator SEBI so that investors are able to make an informed investment decision.
Here are the 16 debt funds currently available in India –
1. Liquid Funds
2. Overnight Funds
3. Corporate Bond Funds
4. Long Duration Funds
5. Medium Duration Funds
6. Low Duration Funds
7. Ultra Short Duration Funds
8. Short Duration Funds
9. Gilt Funds
10. Credit Risk Funds
11. Money Market Funds
12. Floater Fund
13. Banking & PSU Fund
14. Gilt Fund with 10 years constant
15. Dynamic Bond Fund
16. Medium to Long Duration Fund
Tips to picking the right debt fund
A rookie mistake that most investors do is that they try to invest in a scheme based on its past performance. Now a consistently performing debt scheme can be a good option for investment but that shouldn’t be the only way to evaluate. Investors, in order to make sure that they invest in the right type of scheme, must first prioritize, and determine their financial goals. This will help them in understanding what type of debt fund is ideal for them. For example, if they want to invest for the long run then they must consider schemes like gilt funds with 10 year constant or long duration funds that have a longer average portfolio maturity. On the other hand, investors looking to invest for the short run or for adding some liquidity to their portfolio can consider overnight funds or liquid funds as these are easily redeemable, and the money is transferred to their savings account almost immediately.