Debt funds are mutual funds that invest in the fixed income securities like bonds, treasury bills. Debt funds are of many types such as Gilt funds, monthly income plans (MIPs), short-term plans (STPs), liquid funds, and fixed maturity plans (FMPs). Debt funds also include funds that invest in the short-term, medium-term and long-term period.
Debt funds are best suited for investors who are cautious and who do not like investing in the highly volatile equity fund market. Debt funds provide a steady income but the returns are less when compared to the returns of equity funds.
Like a person has a credit score, to prove his worthiness, debt mutual funds also have credit ratings, which certify the issuer’s creditworthiness
There are different types of debt funds in the market, and they fall under this classification:
Open-ended debt mutual funds:
In open-ended mutual funds, the investor may buy or sell the fund at any time of investing. Like equity funds, these funds have an easy entry or exit option. Gilt funds, Income funds, and other short-term funds come under this category.
Close-ended debt mutual funds:
Close-ended schemes can only be invested when the issuer announces the New Fund Offer (NFO) of the scheme. Once the NFO is over, the debt mutual fund closes for investment. They only mature after a period, and the investor cannot exit like open-ended schemes. The investor may only exit if the funds get listed on the stock exchange.
Benefits of debt mutual funds:
The taxation benefits in debt mutual funds are that there is no tax levied on the dividend. If debt mutual funds run more than three years, they are termed as long-term funds and are taxed at 20% after indexation. Indexation takes inflation into account, and the capital gains are reduced. TDS is not deducted from these gains. In the modified tax rules, the tenure of holding a long-term fund has been increased to three years.
Level of risk:
An investor, who is new to the market or has a low-risk appetite, can invest liberally in debt mutual funds. They may not have high returns like equity funds, but are also safer investment options as the risk related to them is quite less.
Ease of investment:
Investing in a debt fund is quite easy. The investor can invest in debt funds through the Systematic Investment Plan (SIP) method where the investor has to invest a certain amount every month in the debt mutual fund.
The advantage of Systematic Transfer Plan (STP):
If an investor has a large corpus to invest, he can invest in debt funds and transfer the amounts through the method of Systematic Transfer Plan wherein the amount is transferred to the investor's choice of equity funds.
A debt fund is suitable for investors who are cautious, have a low-risk appetite and are looking for a steady income.