What are Debt funds? Meaning, Features, Advantages & Disadvantages
Ishu last edited by
You might have heard a lot about mutual funds and its different types recently. So, I thought of sharing my views on one of its types: Debt Funds in India.
Debt funds in India
Debt funds are managed by professionals that invest in high rated fixed income earning investments like State or Central government bonds, RBI bonds, various corporate deposits, money market instruments etc. Simply stating, it is an investment pool like mutual fund or exchange traded fund.
Who likes to invest in Debt funds?
People like you and me with an excess amount of money lying with us look for different investment alternatives. Debt funds mainly suit:
- Those who want to earn better returns than normal bank FD.
- Those who do not want to take higher risk in investing.
What are Debt Funds?
A Debt Fund is just another type of mutual fund. They are valued at NAV basis which keeps on changing daily.
Debt funds mostly invest in fixed income earning investments while equity mutual fund invests in stock markets. This is the major difference between debt fund and equity mutual fund. Investment in debt fund is safer than equity funds.
The returns are taxed when there is a sale of debt fund unlike fixed deposits wherein interest on investment is taxed every year as per the slab.
Since, Debt funds are managed by a highly professional team, so one can be rest assured that his or her money is in safe hands.
Debt funds are highly liquid and one can get money back within a day time. Do keep in mind that certain debt funds may charge exit load for withdrawal of amount within stipulated time frame.
Debt funds: Features
Let us look at some of the features of debt fund which make them unique.
Taxation: One peculiar feature of the debt fund is that mutual fund companies are not liable to deduct any taxes from the earning. Tax liability arises only when an investor redeems units. Moreover, he or she can avail set off gains against any other long term or short term losses.
Liquidity: As discussed earlier, debts fund are highly liquid and one can get redemption amount in its own bank account within a day time.
Advantages of Debt funds
Safer option: The most important benefit of the debt fund is that the investment is not affected by equity market risk. Since professionals invest the pool of investment in highly rated fixed income instruments. A safer investment as compared to equity funds and direct stocks.
Debt fund brings stability in the investment portfolio. Due to this nature of debt fund, one can expect steady returns rather than tumultuous ride in Equity Mutual Funds. One can get regular interest income by investing in debt fund.
Liquidity: It is a highly liquid fund, one can withdraw it any given time and get the redemption amount in the bank account within a day.
Better Returns: One can get decent higher returns than 4% in normal savings bank account and normal bank fixed deposits.
Indexation Benefit: One can avail the benefit of indexation and reduced tax amount on returns.
Taxation: Unlike FD where every year returns are taxed, in debt funds when one sale or withdraw the amount then only tax is levied.
Transaction Cost: The transaction cost in debt fund is low as compared to the mutual fund.
Disadvantages of Debt funds:
- Debt funds mostly invests in government securities, money market instruments, corporate deposits. But, there can be case when such institution or corporate declare itself defaulted in paying interest on such deposits. This makes the debt fund a bit more riskier than the traditional FD.
- There are so many funds available in the market to chose from. Hence, it becomes very confusing for a new investor to chose a suitable fund for him or her.
- Nothing comes free of cost in this world. There is a cost associated with the fund like selling and marketing cost, fund manager or professionals salary etc. Hence, there is a cost associated with the fund which is charged to the investors in the form of expense ratio.
- Individual investors have no control over day to day activities of the fund as professionals are managing the funds.
To conclude, debt funds are highly liquid and safer investment options for those who do not want to take high risks associated with the stock market. These have given far better returns than than traditional investment options. No doubt, certain risk is involved in debt funds also. But, it is lesser in comparison to equity funds or direct stocks.
Sandra last edited by ftForumMod
There are currently 16 different categories of debt funds available. The regulator has segregated the schemes based on the modified duration of the underlying portfolio, while certain categories like Credit Risk Funds and Corporate Bond Funds are defined as per the credit quality of the underlying portfolio. Mutual funds are expected to generate the best risk-reward based on the scheme’s investment mandate and in ultimate good faith of the investor. However, in the quest to generate a higher alpha, some fund managers tend to take on a higher risk. Naive retail investors often bear the brunt of these investment decisions if the promoter companies are unable to pay up.