Debt Fund Meaning

Debt funds are funds through which you lend money to the entities by issuing the instrument. Mostly it invests in certain securities that can provide fixed income in the long run. Treasury bills, commercial papers, and money market instruments are securities where the investment is made. The best part of these securities is that all of them have a pre-decided maturity date and interest rate that you can expect on maturity.

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That's why it is also known as fixed fixed-income securities. Once the debt fund meaning and working are clear, you can easily take advantage of investing in them.

Working of Debt Funds

After you understand the debt fund meaning, you must know how debt funds work. To check high-quality debt instruments, you must check the credit rating. Each debt security has a credit rating that will allow you to find out the possibility of the issuer's default. The higher credit rating indicates a high possibility of default. Sometimes debt security with a low credit rating can give you higher returns. At the same time, high rating securities tend to remain stable.

Who can Invest in Debt Funds?

Debt funds are the best for you if you are a low risk-tolerant investor. Usually, debt funds spread investment through multiple securities for a stable return. Though returns cannot be guaranteed, most of the time, it is as expected. Therefore, low-risk investors find it the best option. Here are a few more types of investors who find these investments ideal:

Short term Investors

Rather than keeping the money in the saving account for 3-12 years, you can invest in debt funds. In this, you can expect 7-9% returns without compromising the liquidity.

Medium term Investors

If you want to invest for 3-5 years and get better rates than the fixed deposits, these are the best option. Moreover, here you have an option of a Monthly income plan where you get monthly payouts from the investment.

Types of Debt Funds

After you know the debt fund meaning, understand its types. The types of debt funds depend on the maturity period of the instrument. There are diverse types of debt mutual funds on which you can invest according to your preference. Here are different types of debt funds:

Short term Debt Funds

These are the debt funds that invest in the instruments with a short maturity term from one to three years. These are the best options for those investors who want a safe option for investment.

Liquid Funds

These funds have maturity within 91 days, so they are risk-free. Rarely there are negative returns, which make it a better option than the saving bank account. Many mutual companies allow you to redeem the liquid fund instantly using unique debit cards.

Gilt Funds

Gilt funds usually invest only in Government securities. Most of the time, the Government defaults the loan it takes in the form of debt securities. These investments have low credit risk, so this is the best choice for fixed income ready for the adverse risk.

Dynamic Bond Funds

In this type of debt fund, you need to keep changing your portfolio according to the fluctuations in interest rate. These funds have an average maturity period. That' is the reason the investments are made in securities with both long and short maturity periods.

Income Funds

Usually, the focus of these funds is generating more profits, and then they have extended maturities. Due to an extension in the maturity period, these funds become more stable. The average maturity period ranges from five to six years.

Fixed Maturity Plans

These are closed-ended debt funds and usually invest in fixed income securities. All fixed maturity plan funds have a fixed maturity date, until the date, your money is locked in. These are sort of fixed deposits that offer tax-efficient returns. However, you cannot expect high returns from these investment funds.

Credit Opportunities Fund

Unlike other types, these funds do not invest according to maturity. They hold a low rated bond and take higher credit risks to earn higher returns. They are comparatively risky funds.

Factors to Consider before Making an Investment

Once you are aware of debt fund meaning and types, you must know about the factors you must consider as an investor. Apart from the type of fund you want to invest in, you must consider these factors:

Risk on Investment

Are you willing to take the risk? No doubt, they are riskier than the bank FDs. When it is about the credit, the fund manager invests in low-credit rated securities that have chances of default. According to interest rate risk, bond prices tend to fall when there is an increase in interest rates.

Returns on Investment

Debt funds do not guarantee fixed returns even though it is the best investment options for fixed returns. Due to the overall rise in the interest rate, the net asset value tends to decrease.

The Cost of Investment

The expense ratio is the charge you pay to the debt fund managers for managing your money. SEBI has limited the expense ratio to 2.25% of the overall assets. However, to overcome the cost of the expense ratio, you need to keep the fund for a long period.

The Type of Investment

If you want to invest for the short-term, then go for liquid funds. If you want an intermediate horizon of investment, then choose dynamic bond funds. You can expect better returns for longer maturity plans.

Financial Goals and Taxation

According to your financial goals, you must choose the debt fund type and maturity period. It will ensure that you can accomplish all your financial goals. The capital gains on debt funds are taxable. A 20% tax after indexation applies Short- term capital gains that you receive from short- term debt funds.

*All savings are provided by the insurer as per the IRDAI approved insurance plan. Standard T&C Apply

Wrapping it up!

This article intends to tell you about debt fund meaning, types and factors to check before investing. Now, you can make a calculative decision for your investment.

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