Debt Mutual Funds — Everything You Need to Know

What are Debt Mutual Funds?

Debt funds are mutual funds where your money is mainly invested in debt or fixed-income instruments issued by the government and companies. These fixed-income instruments could be government bonds, corporate bonds, debentures, and other money market instruments. 

By investing money in such paths, debt mutual funds lower the risk factor compared to equities or stocks. Moreover, these funds can offer good returns, making them a steady option for wealth creation.

Important: Compared to equity mutual funds, debt funds are less risky. Instead of high returns with high risk, you can get stable returns and capital protection with the best debt mutual funds.

How Do Debt Mutual Funds Work?

Debt mutual fund investments are primarily in debt instruments. 

Let’s understand this through an example of a mutual fund called, say, ABC.

• Fund pooling: Funds are pooled from multiple investors
• Investment in bonds: The funds are then invested in corporate and government securities at a specific price 
• Growth of investment: The funds can earn regular interest from the debt instruments in which they invest. This interest goes to the investor, who can get the invested amount at the end of the tenure. 

Note that you can invest in debt funds for usually between 1 day and 3 years. 

What are the Benefits of Investing in Debt Mutual Funds?

Mentioned below are the top debt mutual fund benefits —

• Low Risk: Debt funds are ideal if you wish to increase the stability of your investment portfolio. Since these funds invest a major portion in debt instruments, the impact of stock market fluctuations is usually minimal. 
• High Liquidity: Next on our list of the benefits of debt mutual funds is their high liquidity. As these are ultimately mutual funds, you can easily withdraw your money from the fund in case of an emergency. 
• Flexibility: Just like other mutual funds, debt funds also offer you the option to invest a lump sum amount or via SIP (Systematic Investment Plan). 
• Tax Efficiency: While the UAE doesn’t have any personal income tax, most countries apply this tax. This also extends to mutual funds, where the returns are added to your income.

With that said, most countries also provide tax benefits for debt mutual funds. So if you’ve significant foreign investment and want tax savings, you can certainly invest in debt mutual funds. 

Who Should Invest in Debt Mutual Funds?

If you belong to any of the following, you can certainly consider investing in the best debt mutual funds —

• Low-risk Investors: As debt funds invest in fixed-income assets like bonds, treasury bills, and government securities, they usually carry the lowest risk among mutual funds. With relatively less impact of market fluctuations, these funds are ideal if you have a low risk appetite. 
• Those Seeking Good Returns: Debt mutual funds may not deliver high returns like those of equity mutual funds, which also carry higher risk. However, they offer good, stable returns that usually match or outperform traditional instruments. 
• Short or Medium-term Investments: Debt funds are ideal if you want to go for short or medium-term investments.
• Those Looking for Diversification: If you have a mix of mainly equity funds, you can include debt mutual funds. This can enhance the mix of your investment and increase its stability. 

Main Types of Debt Mutual Funds

Check out the major types of debt mutual funds below —

• Liquid Funds 
  • Typically invest in instruments with a maturity of around up to 91 days
  • Ideal for short-term investments — lower risks and usually higher returns than savings accounts
• Gilt Funds 
  • Mainly invest in bonds and fixed-interest instruments issued by the government 
  • Minimal risk as the investment is done with the government
• Dynamic Bond Funds 
  • Investment in bonds with different maturities 
  • Suitable if you want to invest for a long period — 3 to 5 years — and take a moderate risk
• Credit Risk Funds 
  • Main investment (usually around at least 65%) in corporate bonds with AA rated or below 
  • Slightly higher yields compared to gilt funds, albeit with higher risk
• Money Market Funds 
  • Investment in high-quality short-term debt and money market instruments — maturity period of usually up to 1 year
  • Suitable for those seeking low-risk investment with a short period of maturity
• Corporate Bond Funds 
  • Typically invest at least 80% of their total assets in AA+ or higher-rated corporate bonds
  • Great option if you want debt mutual funds with periodic income and security
• Floater Funds 
  • Usually allocate 65% or more of their corpus in floating rate instruments like certificates of deposit 
  • Low risk, although the debt mutual fund interest rates can keep changing

Besides the categories mentioned above, you can also find debt mutual funds based on the investment tenure — short-term, medium, or long-term funds. 

Debt Mutual Funds vs Fixed Deposits

While discussing debt funds, people often wonder ‘which is better FD or debt mutual fund?’.

Although fixed deposits present a different investment type, they’re often compared to these mutual funds. Let’s take a look at the key differences between these two —

Factors to Consider Before Investing in Debt Mutual Funds

To get the best debt mutual funds for yourself, here’s what you must keep in mind while investing — 

• Risk: While debt funds are low risk in themselves, they can also be categorised further based on their risk. You, as an investor, must choose a fund that matches your risk appetite. 
  For instance, if you want minimal risk, you can go for gilt mutual funds. On the other hand, for higher returns, you can try credit risk funds. 
• Investment Tenure: It’s important to choose a debt fund that is suitable for your planned investment tenure. For short-term investments (weeks or months), you can invest in liquid funds. On the other hand, for longer investments (usually 1 year or more), you can opt for dynamic bond funds. 
• Diversification: In the world of investment, diversification is always a good idea.So if you have mostly safe investments, the best debt mutual funds in your case could be credit risk funds. However, if you have direct equity investments, you can invest in gilt or corporate funds to balance the risk. 
• Fund Performance: While the average return on debt mutual funds of the past doesn’t guarantee how it will perform later, it certainly gives a good idea of what you can expect. This can especially be true when you look at annualised returns over a long term of, say, 3-5 years. 

List of Best Performing Debt Mutual Funds

Here is a list of best performing debt mutual funds for 1 year duration.

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