Mutual funds can be a convenient option if you are looking for alternative forms of investment. There are broadly three different types of mutual funds – equity funds, debt funds and hybrid funds. Starting from high risk to completely risk-averse, there is a fund for every kind of investor. This article will help you understand debt funds in detail. Firstly, let us begin by learning what the term entails.

What are debt funds?

Debt funds also called fixed income funds or bond funds that are pooled investments and hold debt securities, such as corporate bonds, government securities and treasury bills. They are typically used for diversifying a mutual fund portfolio or for income investing. They offer a fixed income in the form of interest and capital appreciation.

Types of debt funds

Here are the different types of debt mutual funds:

• Dynamic bond funds

 These funds invest in instruments of shorter as well as longer maturities. Hence, they have a fluctuating average maturity period based on interest rate calls.

• Income funds 

Income funds are more stable than dynamic bond funds as, more often, they invest in securities with longer maturities. The average maturity of income funds is around five to six years.

• Short-term and ultra short-term debt funds 

These type of funds are most suited at conservative investors as they are not primarily affected by interest rate movements. The maturities range from one to three years. 

• Liquid funds

Liquid funds are almost risk-free as they invest in instruments that have a maturity of not more than ninety-one days. These funds offer similar liquidity as that of a savings bank account but with higher returns. Many mutual fund companies also allow unique debit cards that can be used to redeem liquid funds instantly.

• Gilt funds

Gilt funds strictly invest in high-rated government securities that offer a low credit risk. This makes gilt funds one of the safest options if you want your investments to be completely risk-averse.

• Credit opportunities funds

These are relatively riskier debt funds which do not invest money based on the maturities of debt instruments. They aim to earn higher returns by holding low-rated bonds with higher interest rates or by taking a call on credit risks.

• Fixed maturity plans

Fixed maturity plans are also known as close-ended debt funds. These funds have a fixed horizon to lock in your money. The lock-in period can range in months or years. You can also invest during the initial offer period.

Video about Debt Funds

Watch this video to get the answers to questions like what are debt funds, what are the types of debt funds, what are short term debt funds, what are liquid funds etc.

Things to take care of before you invest in debt funds

Here are some essential factors you may want to bear in mind before investing in debt funds:

• Debt fund managers charge an annual fee known as the total expense ratio to manage your investment portfolio. SEBI has mandated an upper limit of 2.25% of the expense ratio for debt funds.
• You can choose to invest in liquid funds if your short-term investment horizon is in the range of three months to one year. Conversely, two to three years can be a typical tenure for short-term bond funds. For three to five years, dynamic bond funds can be appropriate. The longer the tenure, the better are the returns.
• Keeping your financial goals in mind, you can invest in debt funds to supplement your source of income. For example, if you are retired, you can invest the bulk of your retirement benefits in a debt fund with low risk to enjoy fixed returns.

Conclusion

If you want to invest in mutual funds and comfortable with a moderate degree of risk, investing in debt funds can prove to be a significant investment.