Find Out About The Best Debt Funds In India for 2021.

Buying a debt instrument can be considered as lending money to the entity issuing the instrument. A debt fund invests in fixed-interest generating securities such as corporate bonds, government securities, treasury bills, commercial paper, and other money market instruments. The fundamental reason for investing in debt funds is to earn a steady interest income and capital appreciation. The issuers of debt instruments pre-decide the interest rate you will receive as well as the maturity period. Hence, they are also known as ‘fixed-income’ securities.

Who Should Invest In Debt Funds?

Debt funds try to optimize returns by investing across all classes of securities. This allows debt funds to earn decent returns. However, the returns are not guaranteed. Debt fund returns often fall in a predictable range. This makes them safer avenues for conservative investors. They are also suitable for people with both short-term and medium-term investment horizons. Short-term ranges from three months to one year, while medium-term ranges from three years to five years.

• Short-term debt funds

For a short-term investor, debt funds like liquid funds may be an ideal investment, compared to keeping your money in a saving bank account. Liquid funds offer higher returns in the range of 7%-9% along with similar kinds of liquidity to meet emergency requirements.

• Medium-term debt funds

For a medium-term investor, debt funds like dynamic bond funds are ideal for riding the interest rate volatility. When compared to 5-year bank FDs, debt bond funds offer higher returns. If you are looking to earn a regular income from your investments, then Monthly Income Plans may be a good option. Investing in debt funds is ideal for risk-averse investors as they invest in securities that offer interest at a predefined rate and return the principal invested in full upon maturity.

Best Types of Debt Funds

As mentioned above, there are many types of debt mutual funds, suiting diverse investors. The primary differentiating factor between debt funds is the maturity period of the instruments that they invest in. Following are the different types of debt funds:

• Dynamic Bond Funds

As the name suggests, these are ‘dynamic’ funds. Meaning, the fund manager keeps changing portfolio composition as per the fluctuating interest rate regime. Dynamic bond funds have different average maturity periods as these funds take interest rate calls and invest in instruments of longer and as well as shorter maturities.

• Income Funds

Income Funds take a call on the interest rates and invest predominantly in debt securities with extended maturities. This makes them more stable than dynamic bond funds. The average maturity of income funds is around five to six years.

• Short-Term and Ultra Short-Term Debt Funds

These are debt funds that invest in instruments with shorter maturities, ranging from one year to three years. Short-term funds are ideal for conservative investors as these funds are not affected much by interest rate movements.

• Liquid Funds

Liquid funds invest in debt instruments with a maturity of not more than 91 days. This makes them almost risk-free. Liquid funds have rarely seen negative returns. These funds are better alternatives to savings bank accounts as they provide similar liquidity with higher yields. Many mutual fund companies offer instant redemption on liquid fund investments through unique debit cards.

• Gilt Funds

Gilt Funds invest in only government securities – high-rated securities with very low credit risk. Since the government seldom defaults on the loan it takes in the form of debt instruments; gilt funds are an ideal choice for risk-averse fixed-income investors.

• Credit Opportunities Funds

These are relatively newer debt funds. Unlike other debt funds, credit opportunities funds do not invest as per the maturities of debt instruments. These funds try to earn higher returns by taking a call on credit risks or by holding lower-rated bonds that come with higher interest rates. Credit opportunities funds are relatively riskier debt funds.

• Fixed Maturity Plans

Fixed maturity plans (FMP) are closed-ended debt funds. These funds also invest in fixed income securities such as corporate bonds and government securities. All FMPs have a fixed horizon for which your money will be locked-in. This horizon can be in months or years. However, you can invest only during the initial offer period. It is like a fixed deposit that can deliver superior, tax-efficient returns but does not guarantee high returns.

Conclusion

Dividends offered by all classes of mutual funds are taxed in the classical manner. They are added to your overall income and taxed at your income tax slab rate. Previously, dividends of up to Rs 10 lakh a year were made tax-free in the hands of investors. The classical way of taxation was introduced in Budget 2020. The rate of taxation of capital gains of debt funds depends on the holding period. If the holding period is shorter than three years, then such gains are called short-term capital gains. These gains are taxed at investors’ tax slab. Gains realized after a holding period of three years are termed long-term capital gains. These gains are taxed at 20% after indexation.

Also read - Where Should You Invest For The Highest Returns?

Disclaimer: This article is issued in the general public interest and meant for general information purposes only. Readers are advised not to rely on the contents of the article as conclusive in nature and should research further or consult an expert in this regard.