Personal Finance

Understanding Debt Funds

In Brief:

  • Debt funds are generally considered to be less risky than equity funds. Debt market instruments are like bank fixed deposits, but they can be bought and sold at a price that is governed by interest rate of the instrument, demand/supply and market sentiments.
  •  Debt funds are good for investors looking for capital preservation with regular income as secondary need
  • Corporate and institutions invest more in debt funds than individuals
  • Several investors use debt funds to generate regular income
  • If used well, debt funds can be more tax efficient than Fixed Deposits
  • Returns on debt funds are inversely related to interest rate movements

Debt funds are of three types:

Income or bond funds

  • These invest in medium-long term instruments like corporate bonds, debentures and fixed deposits.
  • These invest in treasury bills, call money, commercial papers
  • Institutional investors dominate this segment

Liquid Money market Schemes

  • Invests in instruments with short term period like commercial paper, treasury bills, call money and inter-corporate deposits
  • Maximum retail investor money in debt funds comes in this category
  • Risk comes from money market volatility – which also creates the possibility of gain due to a sudden increase in rates.

Gilt Schemes

  • Invest in sovereign papers issued by the central government and the state governments
  • Good for investors with least risk-tolerance and willingness to take small cut in returns
  • Least popular of the three categories, with barely any retail investment

There are other plans, too, like monthly income plans (MIPs) and fixed maturity plan (FMP). In MIP every month a fixed amount is invested of which approximately 20% is allocated to equity and the remaining to debt. A fixed maturity plan (FMP) is a close-ended scheme {mutual fund equivalent of a bank fixed deposit}, and has an exit load if redeemed before the maturity period with a maturity period of three months to three years.

Risks associated with debt funds:

  • Interest Rate risk risk emerging from an adverse change in the interest rate prevalent in the market so as to affect the yield on the existing instrument.
  • Credit Risk the risk of default, i.e. the issuer is unable to make further income or principal payments.

Arihant Team
The Arihant Team believes everyone deserves access to sophisticated financial advice. From day one, our mission has been to help make investing easier and accessible to every Indian. Our team of experts are curating informative and research-based article on this blog, to help make investing and managing your money easier for you!

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