Investing 101: Understanding Debt Funds And Its Types

The most popular mutual funds that investors are most eager to invest in are debt funds. They offer two main advantages of flexibility with low risk and stability. Conservative investors tend to invest in these funds due to the benefits availed.

Mutual funds are the most preferred investment option for a newbie or experienced player. The diversification that they offer and regular returns are two main reasons why people want to invest in debt funds so badly. There are many types of debt funds that you need to know in order to make a good investment decision. Knowing the options available will enable you to make a sensible choice and give you an idea about which one will work the best for you. 

Benefits of Debt Funds

  • Most debt mutual funds are not much exposed to the volatility of markets hence people tend to see them as the best option available for investment
  • They provide better returns than any bank FDs or savings accounts
  • The risk in such funds is very low, whereas the stability provided is higher
  • The feature of steady returns and fixed maturity period makes it the best choice for achieving investment goals
  • It is suitable for new investors who have a low-risk appetite
  • There is high liquidity provided as you can encash or redeem the investment whenever you may like

Types of Debt Mutual Funds

After knowing some of the benefits of investing in debt funds, let’s look at their types before investing in them.

  1. Income Funds: Income funds work in a way where it invests in different debt securities with varying maturity periods, but most of them are investments having longer tenure. The average maturity period of such funds is around 5-6 years. They invest in corporate bonds and government security, keeping changing interest rates into accounts. It is best for those who have a slight high-risk appetite and a long investment horizon.
  2. Dynamic Bond Funds: Dynamic bond funds are just what the name suggests. They move dynamically from long-term and short-term funds. The maturity period of these profiles differ. The funds move across all the classes of money market instruments and debt classes, keeping fluctuating interest regimes into account. It is best suitable for those who have a medium to high-risk appetite and look for something dynamic.
  3. Liquid Funds: Liquid funds are the type where they can be converted to cash very easily. This type of fund has a low maturity that is 91 days. Additionally, the low tenure of these funds makes them almost risk-free, also they tend to provide the most stable returns. The investment is majorly in CDs, Certificate of Deposit, or Treasury Bills. Liquid funds are the best alternative for those who have their money kept idle in some bank account and want to put the money to use for generating reliable returns.
  4. Short-Term Funds: Just like the name suggests, this type has a shorter maturity period that ranges from 1 to 3 years. Additionally, the investments are mainly in debt, money market instruments, and government securities. Short-term funds are suitable for those having a risk appetite from low to moderate levels. Moreover, these funds show excellent performance when the interest rates are higher. If you have a tenure of 9-12 months to invest the money and your risk appetite is low to moderate, you can surely invest in short-term funds. 
  5. Credit Opportunities Funds: Credit Opportunities Fund makes investments in different types of instruments. This investment ranges from short to long-term maturity with generating high interest as the view in the account. It is appropriate for those who aim for greater returns but also want to take some risk.
  6. Gilt Funds: Gilt funds only invest in issues of security by state and central governments. Additionally, the range of maturity period of the investments made lies from medium to long term. These are government-issued funds so there is no default or credit risk, your capital remains to be in safe hands. That does not imply that there is no risk at all, there is some risk as government securities are vulnerable to any type of changes in interest rates. Gilt funds are best suited for those who have the willingness to invest for the long term and options that are backed by the government.
  7. Fixed Maturity Plans: FMPs have a lock-in period that stays fixed. That can range from months to years. Due to this lock-in period, the Fixed Maturity Plans are not quite affected by the dynamic interest rates. So Net Asset Value remains the same for the fund. Additionally, FMPs are tax-efficient and close-ended, which makes them the best option for fixed deposits. For those who are willing to deposit their money for a priorly fixed period but don’t like fluctuations in interest rates, FMPs are best suited for them.
  8. Ultra Short-Term Funds: This type of fund has an even shorter maturity period than short-term funds, which is less than a year. The investment is majorly done in long-term security, only a small portion is invested. There is low risk and it’s best for someone whose investment horizon is 1-12 months.

Every debt fund has a system of credit rating that allows the investors to understand priorly about the possibility of default by any debt issuer. This is to be known to be aware of the debt issuer who might default while disbursing interest and principal. People have this doubt that debt funds invest in low-quality debt instruments?, the answer to this is Yes. There are various factors looking at which a fund manager will select securities. Choosing low-quality debt funds brings the opportunity to earn higher returns, but they take a calculated risk.

Mutual funds are the most preferred investment option for a newbie or experienced player. The diversification that they offer and regular returns are two main reasons why people want to invest in debt funds so badly. After knowing the types and benefits of investing in debt mutual funds, make your investment decision wisely.