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Which type of debt mutual fund suits your investment goal?

Author: Adhil Shetty/Wednesday, August 14, 2019/Categories: Exclusive

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Which type of debt mutual fund suits your investment goal?

Mutual funds give you a wide variety of investment options that can broadly be grouped into two categories: equity and debt-oriented schemes. Debt funds use the corpus to invest in several fixed income instruments such as money market instruments, treasury bills, corporate bonds, etc. to generate returns. Therefore, the risk associated with debt mutual funds is comparatively lower than the equity-oriented funds. However, as the risk offered by debt mutual funds are low, they usually provide a lower return in comparison to the equity mutual funds.

That said, every debt investment scheme has a distinct role to play when you work towards achieving your short and long-term financial goals. Find out what are the best options in debt mutual funds... 

LIQUID FUNDS

If you are looking to invest in a low-risk investment product for a short duration, liquid funds could be the right product for you. Liquid funds use the corpus to invest in money market instruments and bonds with a maturity period of fewer than 91 days to generate returns.They’re ideal for safely parking lump sums to earn a rate of return higher than savings accounts or comparable to fixed deposits. Liquid funds offer quick entry and exit to the investors that make it highly attractive for short duration investments and for people seeking high liquidity.

SHORT DURATION FUNDS

Short duration funds use the corpus to invest in debt instruments with an average maturity period of around 1 to 3 years. Short duration fund investments carry low risk and can be a good alternative to FDs of the corresponding tenure.Investors who want to invest in FDs for 1 to 3 years and are looking for an alternative can explore investment opportunity in a short duration fund to avoid paying the tax deducted at source (TDS).

ULTRA-SHORT DURATION FUNDS

Ultra-short mutual funds use the corpus to invest in debt instruments with a maturity period of less than 1 year. They carry low risk and the returns are moderate. Investors looking to invest their money for a period of 1 to 12 months can opt for ultra-short-term funds. They have the potential to allow a higher return in comparison to liquid funds. However, the interest rate risk is comparatively higher in these types of funds.

DYNAMIC BOND FUNDS

Dynamic bond funds focus on investing the corpus in debt instruments of different maturities depending on the interest rate scenario and the discretion of the fund manager. So, the underlying debt investment can be an instrument with short-term maturity or long-term maturity, depending on market conditions. Investors looking for a lower risk option than equity-oriented mutual funds, and, at the same time, want moderate returns, should consider investing in dynamic bond funds. These products are ideal for long-term investors who want an attractive return and are ready to take a higher risk.

CREDIT RISK FUNDS

These types of funds target the credit rating of corporate bonds and their underlying debt products to generate returns. Credit risk funds carry a higher risk than most other debt funds, but at the same time, have the potential to generate an attractive return.Investors looking to invest for thelongterm and want to take lower risk than equity mutual funds can explore this option.

GILT FUNDS

As the name suggests, these funds invest a major portion of the corpus in government securities to generate returns.Investors having an extremely lowrisk appetite and looking to invest for a longer tenure can consider investing in gilt funds. However, do note that gilt funds carry interest rate risks. The higher the maturity periods of underlying bonds, the greater the gilt fund’s sensitivity to interest rate movements.

FIXED MATURITY PLANS (FMP)

Investors who are looking for an instrument similar to FDs and are ready for a lock-in period can invest in FMPs. However, do note that FMP investmentscan be made only during the offer periods. Though these funds don’t give an assured return, they often beat the indicative returns claimed at the time of fund offer.

HOW ARE DEBT FUND INVESTMENTS TAXED?

The capital gains from debt fund investments with holding periods of less than three years are called short-term capital gains (STCG). On the other hand, if the holding period exceeds three years, such gains are called long-term capital gains (LTCG).STCG is taxed at the respective slab rate applicable to the investor, whereas LTCG is taxed at the rate of 20% with indexation benefit.

IMPORTANT THINGS TO KNOW....

There’s no doubt that debt funds carry lower risk than equity mutual funds, but if you think they are risk-free, you’re making a mistake. Investing in debt mutual funds will involve the risk of default by the issuer, interest rate risk, so on and so forth. A few months back, some Non Banking Financial Companies (NBFCs) failed to repay their corporate bond debt resulting in losses to debt mutual funds which had exposure in bonds of such companies. Thus, an investor holding debt funds with exposure in such companies suffered losses.

Investors should also factor in that some debt funds levy exit load if the investment is redeemed before the threshold period. So, invest in such a fund only when you are sure that you won’t need to liquidate your investment before the threshold period. Also, debt funds, like equity funds, allow investors to invest their money in lump-sum or through Systematic Investment Plans (SIP) mode. (The author is CEO, BankBazaar.com)

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