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When it comes to investing, many people immediately think of stocks and equities. However, debt funds offer another avenue worth exploring for those looking to grow savings while maintaining a conservative approach to risk.

What is a Debt Fund?

A debt fund is a type of mutual fund that invests in fixed-income securities like government bonds, corporate bonds, treasury bills, and commercial papers. Unlike equity funds that invest in stocks, debt funds focus on instruments that typically offer more predictable returns through regular interest payments.

When you invest in a debt fund, the fund manager pools your money with other investors and invests in various debt instruments with pre-decided maturity dates and interest rates. While debt funds are among the lower-risk mutual fund categories, they’re subject to market risks and do not offer guaranteed returns.

How Do Debt Funds Work?

Fund managers select quality instruments based on credit ratings (AAA, AA, etc.) from agencies like CRISIL, ICRA, or CARE. They manage interest rate risk by adjusting portfolio duration, as bond prices and interest rates move inversely.

Debt funds generate returns through interest income and capital appreciation when bond values rise. The NAV fluctuates based on interest rates and credit quality, making returns market-linked and not guaranteed.

Types of Debt Funds

By Duration:

– Liquid Funds: 91-day maturity, high liquidity, suitable for short-term parking

– Ultra Short/Low Duration: 3-12 months, moderate returns with low risk

– Short to Medium Duration: 1-4 years, balanced risk-return profile

– Long Duration: 7+ years, higher potential returns with increased interest rate risk

By Securities:

– Gilt Funds: Government securities, minimal credit risk

– Corporate Bond Funds: AAA-rated corporate bonds, high quality

– Banking & PSU Funds: Bank and PSU debt, relatively safer

– Credit Risk Funds: Lower-rated bonds, higher risk and potential returns

– Dynamic Bond Funds: Flexible maturity based on interest rate outlook

Who Should Invest in Debt Funds?

– Conservative investors with lower risk appetite prioritizing capital preservation

– Short to medium-term investors saving for goals from a few months to several years

– Income seekers looking for regular income streams

– Portfolio diversifiers wanting to reduce overall volatility

– First-time investors starting with lower-risk mutual fund options

Benefits of Investing in Debt Funds

1. More Stable Returns: Less volatile than equity funds with relatively predictable income streams

2. Professional Management: Expert fund managers monitor credit quality and interest rate trends

3. High Liquidity: Quick redemptions, typically within 1-2 business days for liquid funds

4. Diversification: Spread across multiple instruments and issuers

5. Market Access: Access to wholesale instruments like commercial papers and corporate bonds

6. Flexible Options: Categories for various investment horizons

7. Potential Tax Benefits: Indexation benefits on long-term gains

Risks Associated with Debt Funds

1. Credit Risk: Issuer may default on payments; ratings can change

2. Interest Rate Risk: Bond values fall when interest rates rise; long-duration funds are more sensitive

3. Liquidity Risk: Difficulty selling securities quickly in certain market conditions

4. Reinvestment Risk: Lower returns when reinvesting at reduced interest rates

5. Market Risk: Economic factors and regulatory changes impact performance

Important: Debt funds carry market risks and don’t offer guaranteed returns. They’re not covered by DICGC insurance like bank deposits.

Taxation on Debt Funds

– Short-Term (< 3 years): Added to income, taxed at your slab rate

– Long-Term (> 3 years): 20% tax with indexation benefits

Tax laws are subject to change. Consult a tax professional for personalized advice.

How to Choose the Right Debt Fund

1. Match Investment Horizon: Align fund duration with your financial goals

2. Assess Risk Tolerance: Choose between safer gilt/corporate bond funds or higher-return credit risk funds

3. Check Credit Quality: Prefer AAA/AA-rated securities for lower risk

4. Review Expense Ratio: Lower fees significantly impact net returns

5. Evaluate Performance: Compare with similar funds and benchmarks

6. Understand Strategy: Review investment approach and portfolio duration

7. Check Fund Manager Track Record: Experience matters in debt management

The alternate method!

A smart alternative to putting efforts and manually choosing the fund is to simply invest with Curie Money! All you have to do is just park your money like you do with a savings account. Curie Money smartly invests your money in liquid funds, which are liquidated instantaneously as and when you need funds. This essentially means that you earn returns on the money without the hassle of going through the selection and investment process!

Frequently Asked Questions

Are debt funds safe?

Debt funds are lower-risk but not risk-free. They carry credit, interest rate, and market risks. Unlike FDs, they’re not covered by deposit insurance.

How are they different from fixed deposits?

– Returns: Market-linked (debt funds) vs. predetermined (FDs)

– Liquidity: Higher without penalties vs. early withdrawal charges

– Risk: Market risks vs. DICGC insurance (up to ₹5 lakh)

– Taxation: Indexation benefits vs. slab-rate taxation

Can I withdraw anytime?

Yes, most debt funds offer high liquidity with redemptions in 1-3 business days. Some may have exit loads for early withdrawals. This liquidity can also be enjoyed with Curie Money! As and when you need funds, your investment of equivalent value is liquidated instantaneously, providing your with unmatched convenience! 

What returns can I expect?

Returns vary by category and market conditions. Liquid funds offer moderate returns, while longer-duration funds may provide higher returns with more volatility. Returns are not guaranteed.

Which is suitable for beginners?

Liquid or ultra-short duration funds with high-quality securities offer relatively stable returns and high liquidity for first-time investors.

Conclusion

Debt funds offer exposure to fixed-income securities with professional management for various investment goals. While they’re lower-risk than equity funds, they carry market risks and don’t offer guaranteed returns or deposit insurance coverage.

When choosing a debt fund, consider your investment horizon, risk tolerance, portfolio quality, expense ratio, and performance. Ensure alignment with your overall financial plan.

For those seeking better returns on savings with instant UPI access, Curie Money offers investment-linked payment solutions. It invests in SEBI-regulated liquid funds managed by ICICI Prudential and Bajaj Finserv Asset Management, combining potential for better returns with instant accessibility for daily transactions.

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Disclaimers

Mutual fund investments are subject to market risks. Read all scheme-related documents carefully. Past performance is not indicative of future results.

Debt funds don’t offer guaranteed returns. Returns are market-linked and vary based on interest rates, credit quality, and market conditions. This information is for educational purposes only, not investment advice.

Debt funds carry credit, interest rate, liquidity, and market risks. They’re not bank deposits and lack DICGC insurance coverage. Tax laws may change; consult a tax professional.

Assess your investment objectives, risk tolerance, and financial situation before investing. Consider consulting a qualified financial advisor.

About Curie Money: India’s first UPI app that grows your money. Funds invested in liquid mutual funds managed by ICICI Prudential and Bajaj Finserv Asset Management. Banking via YES Bank. AMFI-registered distributor (ARN: 257706). NPCI-approved, PCI-DSS compliant, SEBI-regulated. Returns are market-linked, not guaranteed.