Conservative investors looking for safe returns on their investments often go for debt mutual funds. Here we talk about five things that every investor should know about debt mutual funds.
#1 – What are Debt Funds?
As the name suggests, these funds invest in securities like treasury bills or corporate bonds or commercial papers, government securities, and other money market instruments that generate fixed income. Since all these financial instruments have a pre-decided maturity date and interest rate, the returns on them are not affected by market fluctuations or any other developments.
#2 – How do Debt Mutual Funds Work?
Debt mutual funds invest in an array of securities with different credit ratings that reflect the creditworthiness of the debt issuer. While instruments with a high credit rating are the most preferred choice for investment, these funds also do invest in instruments with low ratings. This is because the decision to invest in varied securities is based on several factors including the possibility of earning higher returns. If the risk pays off, the fund may earn good returns which in turn boosts the NAV of the mutual funds. The debt fund manager may also decide to invest in long-term or short-term debt instruments depending on the interest rate scenario.
#3 – What Type of Returns are Offered by Debt Funds?
Since debt funds invest in fixed return securities, the risk level is low in comparison to other types of funds. But one thing investors need to know is that although debt funds invest in fixed income securities, the returns from them are not guaranteed. The NAV of mutual funds that invest in debt instruments tends to fall with a rise in the overall interest rates in the economy. The returns generated by this category of mutual funds, however, often fall in a predictable range which makes them highly popular amongst conservative investors.
#5 – What are the Different Types of Debt Mutual Funds?
Different types of debt funds with investments in securities of different durations to suit the requirements of investors are being offered by mutual funds.
- Liquid Funds – They invest in money market instruments with a maturity of up to 91 days.
- Money Market Funds – They invest in money market instruments with a maturity of a maximum of one year.
- Dynamic Bond Funds – The composition of these funds keeps on changing in line with the prevailing interest rate scenario.
- GILT Funds– These funds invest only in government securities and so are ideal for investors with low-risk tolerance.
- Income Funds-These funds invest mainly in debt securities with extended maturities depending on the interest rate scenario. The average maturity of these funds is around five to six years.
#5 – Why Invest in Debt Funds?
Debt mutual funds can be used to generate an alternative source of income to supplement your salary. Again, retired people can opt for investment in debt mutual funds to earn predictable returns. But do remember that capital gains earned from your investment in a debt mutual fund are taxable at rates that depend on your holding period.