Debt Funds explained: If you invest in fixed income instruments is your financial goal, then debt funds should be considered. But, let's first understand what debt funds are, what are the various types and what are the benefits of investing your money in them?
Debt funds are schemes that invest in fixed income instruments such as corporate/government bonds, corporate debt securities and money market instruments. The portfolio may consist of these securities or a combination of them, depending on the scheme.
Investors have a range of options in debt funds based on their risk appetite and investment timeframe. For short-term investments from 1 day to three months, overnight/liquid funds are suitable. Ultra-short-term funds are ideal for 3 months to a year, while short-term funds or corporate bond funds cater to 1-3 years, says an ET report.
Long-term Gsec funds, with a maturity of more than 3 years, are designed to capitalize on interest rate fluctuations. Those looking for predictable returns can opt for target maturity funds.
A debt scheme generates income through two main routes: first, through interest payments on your securities holdings, resulting in accumulated revenue. Second, fluctuations interest rate cause bond prices to rise or fall, leading to capital gains or losses. The overall return to the investor is a combination of both types of gains. The component that represents capital gains or losses is also known as the mark-to-market (MTM) return.
Debt funds offer high liquidity, allowing withdrawals before the cut-off time to be reflected in the bank account on the next business day. Investors can switch between schemes as needed, unlike fixed deposits which can incur penalties for premature withdrawals.
Debt funds also present the opportunity for capital appreciation when interest rates fall, a feature absent from other fixed income products.
Taxation of debt mutual funds is in line with fixed income products from April 1, 2023. Capital gains from these schemes are taxed based on the individual's income tax slab, with no long-term gains or benefits indexing.