What is a Debt Fund?

What is a Debt Fund?

Debt funds are investment instruments that have 5 features –

  1. Low risk

  2. High assured returns between 7 to 8 % (which are not dependent on the market)

  3. High liquidity (you can take your money out when you need it)

  4. Low volatility (as it’s not market dependent and returns are mainly fixed)

  5. High benefit in taxation.

Unlike equity mutual funds that invest money in stocks and shares, debt funds are mutual funds that invest your money in fixed-income securities for which interest is gained.

Simply put, you can think of a debt fund as a loan that you give to a company, institute or the government on which you receive fixed interest – meaning, you make money on it.

Debt funds can help diversify an investor’s portfolio by investing in different types of assets. If one type of asset (e.g., corporate bonds) is performing poorly or has become too risky for investors to consider investing in anymore, then the investor may switch to another type (e.g., junk bonds).

This diversification helps reduce risk and increase potential returns for investors who choose to diversify their portfolio by investing in debt funds rather than holding all their investments in one particular asset class such as stocks or bonds alone.

How do Debt Funds Work?

How do Debt Funds Work?

Debt fund investment is when you invest in debt instruments to generate income and capital appreciation.

Debt funds allow investors to participate in the returns of Indian corporate bonds through an easy-to-understand fund structure without managing their own portfolios. They are primarily investments in government securities and corporate bonds issued by banks, financial institutions and insurance companies. The portfolios are diversified across all bond issuers, maturities and sectors (mixed).

Debt fund investment is when you invest in debt instruments to generate income and capital appreciation.

Debt funds allow investors to participate in the returns of Indian corporate bonds through an easy-to-understand fund structure without managing their own portfolios. They are primarily investments in government securities and corporate bonds issued by banks, financial institutions and insurance companies. The portfolios are diversified across all bond issuers, maturities and sectors (mixed).

Benefits of Investing in Debt Funds

Independent of
Equity Market

Set Reminders to Repay on Time

Debt funds are a type of investment that is not influenced by the stock market. This is because debt funds are based on lending money to a company or government, rather than investing in stocks. The interest from the loan is then used to pay the investors, which makes debt funds much less risky than equity investments. This stability makes debt funds an attractive investment for those who are looking to protect their capital.

Higher Interest
Rates

Debt funds can provide you with the advantage of higher interest rates. If you are looking for long-term investment and don’t want to deal with the volatility of the stock market, debt funds can be an excellent choice for you.

Debt funds are considered liquid investments that offer investors access to high-quality companies at attractive valuations. You’ll also enjoy the superior liquidity and flexibility of debt investments compared to equity investments.

Source of Income

The primary benefit of debt funds is that they provide investors with a steady stream of income while they wait for their investments to mature. The payment on the debt obligation is regularly distributed through interest payments or principal repayments.

Investors don’t have to worry about their investments going bad due to their ability to quickly exit the investment when they need cash. The returns on debt funds will always be available to investors because they can be cashed out at any time without penalty or other restrictions.

Lower Risk

Debt funds are considered low-risk investments because reliable borrowers back them with strong credit profiles. Debt funds also have lower risk than other equities as they do not depend on the earnings of specific companies.          

The risk of default is minimal since these funds are guaranteed by government agencies such as the RBI. Debt funds are an excellent choice if you’re looking for a place to put your money where it will be safe.

Diversification

Diversification is another crucial benefit investors can enjoy when they invest in debt funds. The idea behind this advantage is that you can reduce your overall risk by investing in a wide range of assets. Basically, it ensures that you have more options when making investment decisions, thus reducing your overall risk level.

Debt funds have different types of assets like government securities, corporate bonds, securitised products and other financial instruments. This ensures that the investor does not put all his eggs in one basket.

Tax-efficient

Debt funds are tax-efficient because you don’t have to worry about capital gains taxes when you sell your investments. Because the profit from these types of investments is taxed at lower rates, investors who hold them for a longer period of time can put more money into their retirement accounts without incurring a higher tax bill than they would have if they were just investing in regular stocks or bonds.

This can help you save more for retirement than if you were just investing in stocks or bonds directly because you won’t have to pay taxes on that income until it’s time to withdraw it from your account.

You can raise your credit score by creating a good credit history. Here are some things you can do to help get there:

Pay off any outstanding debts. If you have any unpaid bills, make an effort to pay them off as soon as possible. This will improve your score because it shows that you can pay back what you owe.

Avoid opening new accounts in a short amount of time. Opening several new accounts within a short period of time can lower your scores because banks will see this as a sign of financial stress and may close your account if they feel that their money is at risk.

Utilize your available credit limits on existing accounts optimally so that your total available credit is as high as possible while still keeping an active balance on each account. This will help raise your scores because it shows that you can use credit responsibly and manage debt obligations effectively.

How Can You ImproveCIBIL Score?

Set Reminders to Repay on Time

When you don’t repay your existing debt on time, it can negatively affect your credit score by pushing it down. Therefore, it is important to maintain discipline while paying your loan and EMIs. To do this better, you can set reminders for your payments so it becomes easier for you to pay them on time.

Choose a Longer Tenure When You Take a Loan

When you are trying to get a loan, make sure you choose a longer tenure for your payment. This will ensure that your EMI is low so you can pay it back on time without any issues.

Try Maintaining a Healthy Credit Mix

Credit Mix is the range of credit products and services you have on your record. The higher the number of types of credit you have, the better your score will be.

A healthy Credit Mix shows that you understand the different types of credit that are available to you and how these can help improve your financial situation. It also means you know how to manage every kind of loan or credit product.

Say No to Being a Joint Account Holder

The CIBIL score is the most important factor for banks to consider when deciding whether to give you a loan. A high CIBIL score means that you are a responsible borrower and that your financial situation is stable.

To improve your CIBIL score quickly, say no to being a joint account holder. Being a joint account holder means that both partners share the responsibility of repaying the loan together. This means that one person’s credit history will be used as the other person’s score. This can affect your credit score as well as increase the total amount of debt that you have on your account.

Create Credit History by Choosing Forms of Credit

You can raise your credit score by creating a good credit history. Here are some things you can do to help get there:

Pay off any outstanding debts. If you have any unpaid bills, make an effort to pay them off as soon as possible. This will improve your score because it shows that you can pay back what you owe.

Avoid opening new accounts in a short amount of time. Opening several new accounts within a short period of time can lower your scores because banks will see this as a sign of financial stress and may close your account if they feel that their money is at risk.

Utilize your available credit limits on existing accounts optimally so that your total available credit is as high as possible while still keeping an active balance on each account. This will help raise your scores because it shows that you can use credit responsibly and manage debt obligations effectively.

Check for Errors in Your Credit Report

If you want to improve your CIBIL score, you should keep a check for errors in your credit report. Most of these errors are easy to correct, but if you fail to do so, it can cause serious problems for your credit history.

A number of different types of errors are reported, including missing payments and accounts that are not updated regularly. You should pay close attention to these as they could prevent you from getting approved for a loan or other financial services.

If there’s an error in your report, you must take action immediately. Call the credit bureau and let them know about the issue so they can fix it immediately. This will make sure that there’s no more damage done to your credit report while they wait for another update from their system.

Who Should Invest in a Debt Fund?

Who Should Invest in a Debt Fund?

People looking for low-risk investment opportunities may want to consider investing in a debt fund. Investors in debt funds typically seek to preserve capital and earn income through regular interest payments from the fund’s holdings. For these reasons, debt funds may be appropriate for investors who are retired or nearing retirement, as well as those who have a low tolerance for risk.

People looking for low-risk investment opportunities may want to consider investing in a debt fund. Investors in debt funds typically seek to preserve capital and earn income through regular interest payments from the fund’s holdings. For these reasons, debt funds may be appropriate for investors who are retired or nearing retirement, as well as those who have a low tolerance for risk.

Types of Debt Funds

1

Overnight Funds

Overnight funds are investment instruments that provide investors with the opportunity to earn a return on their idle cash. It is a type of mutual fund that invests in debt instruments with maturities of one day or less.

Overnight funds are best for businessmen or entrepreneurs who frequently need to store significant amounts of money for only a brief period until it can be used for other purposes.

Overnight funds are managed by professional fund managers who use their expertise and market knowledge to generate returns for investors. Securities in these funds mature the next day, meaning these funds are less exposed to interest rate or default risk in comparison to other debt funds. Of course, this low-risk profile also means they tend to offer the least return.

2

Liquid Funds

Liquid funds are debt mutual funds that lend money to companies for up to 91 days. They are considered much safer than other types of mutual funds because of their very short lending duration. Liquid funds are ideal for people who want to save money for emergencies, as there is almost no risk of loss if the investment is held for at least one month.

Liquid funds are a good choice for those who have a lot of cash lying around that they aren't investing anywhere and who want a short-duration investment option with lower risks.

3

Ultra short-term funds

Ultra-short-term funds are mutual funds that invest in debt instruments with maturities of up to one year. The main advantage of investing in ultra-short-term funds is that they offer high returns with low risk. This is because these funds invest in highly rated debt instruments that have a low probability of default.

Another advantage of investing in ultra-short-term funds is that they provide liquidity. This means that you can easily withdraw your money when you need it.

4

Low Duration Funds

Low-duration funds are debt funds that allow you to invest your money in short-term debt securities that come with an average duration of 6 to 12 months. While this may sound similar to liquid funds, these low-duration funds come with a higher credit risk because they usually hold assets of lower credit quality. This means that they have a higher interest rate and credit risk.

5

Money Market Funds

Money market debt funds, or money market funds as they are also known, offer investors access to short-term debt instruments. These investment products have a very low-interest rate, typically below 4% per annum.

The main benefit of investing in a money market fund is its low fees and charges. This makes them suitable for individuals who want to invest their savings and are not interested in the long-term benefits of an equity investment.

Investors can buy units through an online broker or a stockbroker, who then holds the assets on their behalf until maturity. The unit's value will increase with the economy's growth and the issuer's performance.

6

Short term funds

Short-term funds are a good option for investors who want to earn regular income without taking on too much risk.

Short-term bond funds invest in debt instruments with maturities of up to three years. The fund managers invest in a variety of debt instruments such as government securities, corporate bonds, and treasury bills. The main benefit of investing in a short-term bond fund is that it offers relatively high liquidity compared to other fixed-income options such as long-term bonds or FDs (fixed deposits).

7

Medium Duration Funds

Medium-duration funds are a type of mutual fund that invests in debt instruments with maturities of three to four years. These funds are considered to be less risky than long-term debt funds, but more volatile than short-term debt funds. Medium-duration funds offer higher returns than short-term debt funds, but with more risk.

Investors who are looking for stability and moderate returns may consider investing in medium-duration funds. The average return for this is around 7%; however, a savings account with FreoSave can give you the same return without putting your money at risk.

8

Medium to Long Duration Funds

Medium to long-duration debt funds invests in securities with a maturity period of 4 to 7 years. Such funds carry high-interest rate risk, and can be a good choice when the economy is doing well, and the interest rates are falling.

9

Long Duration Funds

Long-duration funds are mutual fund schemes in long-term government bonds and other debt instruments with maturities of 10 years and above. The primary objective of these funds is to generate income for investors through interest payments on the underlying investments.

Long-duration funds are relatively less volatile than other debt mutual fund schemes, making them ideal for risk-averse investors seeking stability in their portfolios. However, these funds also come with certain risks, such as the interest rate risk associated with long-term bonds. Nevertheless, long-duration funds can be a valuable addition to any investor’s portfolio, especially if held for the long term.

10

Dynamic Bond Funds

As the name suggests, dynamic bond funds are the funds in which your fund manager keeps changing your portfolio based on the fluctuating interest rate. Dynamic bond funds can have different maturity periods because they usually invest in instruments of both longer and shorter maturity periods.

11

Corporate Bond Funds

Corporate bond funds are like the debtors with the best possible credit rating. Companies with this high of a rating are financially strong and have a high probability of being able to pay back their lenders on time. These types of funds are ideal for people who don't need the money for at least 2 to 3 years. They often times outperform bank fixed deposits that have similar durations, and if you hold them for three or more years, you get tax-efficient returns since they qualify for indexation benefits.

12

Credit Risk Funds

A Credit risk funds are designed to take on higher levels of risk than other types of funds. The goal is to maximise your return while minimising the amount of credit you need to invest. These funds invest in debt securities of companies with a lower credit rating. Credit risk funds invest in subprime and leveraged loans, which are secured by collateral such as real estate, vehicles and other assets. These loans are more likely to default than companies with better ratings.

The main advantage of investing in credit risk funds is that it provides diversification benefits over standard bond funds. It also offers the opportunity to earn higher returns than fixed-income investments such as bank deposits and cash reserves.

13

Banking and PSU Funds

Banks and public sector undertakings (PSUs) are the two most important types of investment funds. Banking debt funds invest primarily in medium-term time deposits with banks. Time deposit refers to money deposited for a specific period of time at a fixed interest rate that does not change after it has been deposited. This means that even if interest rates go down, your money will still earn the same interest rate until the maturity date of your deposit note.

On the other hand, PSU bond funds invest primarily in short-term notes issued by the government or public sector enterprises (PSEs). Both types of debt funds have their benefits but may not be suitable for everyone.

14

Gilt Funds

Gilt funds are a type of debt fund that invest in gilts or bonds issued by the government. Gilt funds typically invest in various gilt issues and can be used to help diversify an investment portfolio. They have the advantage of being relatively low risk and are suitable for those with a limited appetite for risk but still want to participate in the equity markets.

Gilt funds are generally very liquid funds with regular reviews and trade throughout the day on a secondary market. They can also be bought and sold directly from your broker's website.

Gilt funds are usually considered appropriate for investors with moderate risk tolerance and various bonds available to suit your requirements.

15

Gilt Funds With 10-Year Constant Duration

Investment vehicles that invest in securities by the Reserve Bank of India are known as the Gilt Funds. As the name suggests, a gilt fund with a ten-year constant duration comes with a fixed maturity period of 10 years, and it is meant for people who have lower risk tolerance.

16

Floating Rate Funds

Floating rate funds have a floating rate of interest. This means that the interest paid by the fund is never fixed. Instead, it changes according to market conditions and other factors. Floating rate funds are popular because they offer the flexibility to invest in a wide range of investments without any restrictions on their interest rate.

The main benefit of floating rate funds is that you can use them for short-term investment purposes. This means you can use them for saving or even investing in emergency funds.

1

Overnight Funds

Overnight funds are investment instruments that provide investors with the opportunity to earn a return on their idle cash. It is a type of mutual fund that invests in debt instruments with maturities of one day or less.

Overnight funds are best for businessmen or entrepreneurs who frequently need to store significant amounts of money for only a brief period until it can be used for other purposes.

Overnight funds are managed by professional fund managers who use their expertise and market knowledge to generate returns for investors. Securities in these funds mature the next day, meaning these funds are less exposed to interest rate or default risk in comparison to other debt funds. Of course, this low-risk profile also means they tend to offer the least return.

2

Liquid Funds

Liquid funds are debt mutual funds that lend money to companies for up to 91 days. They are considered much safer than other types of mutual funds because of their very short lending duration. Liquid funds are ideal for people who want to save money for emergencies, as there is almost no risk of loss if the investment is held for at least one month.

Liquid funds are a good choice for those who have a lot of cash lying around that they aren't investing anywhere and who want a short-duration investment option with lower risks.

3

Ultra short-term funds

Ultra-short-term funds are mutual funds that invest in debt instruments with maturities of up to one year. The main advantage of investing in ultra-short-term funds is that they offer high returns with low risk. This is because these funds invest in highly rated debt instruments that have a low probability of default.

Another advantage of investing in ultra-short-term funds is that they provide liquidity. This means that you can easily withdraw your money when you need it.

4

Low Duration Funds

Low-duration funds are debt funds that allow you to invest your money in short-term debt securities that come with an average duration of 6 to 12 months. While this may sound similar to liquid funds, these low-duration funds come with a higher credit risk because they usually hold assets of lower credit quality. This means that they have a higher interest rate and credit risk.

5

Money Market Funds

Money market debt funds, or money market funds as they are also known, offer investors access to short-term debt instruments. These investment products have a very low-interest rate, typically below 4% per annum.

The main benefit of investing in a money market fund is its low fees and charges. This makes them suitable for individuals who want to invest their savings and are not interested in the long-term benefits of an equity investment.

Investors can buy units through an online broker or a stockbroker, who then holds the assets on their behalf until maturity. The unit's value will increase with the economy's growth and the issuer's performance.

6

Short term funds

Short-term funds are a good option for investors who want to earn regular income without taking on too much risk.

Short-term bond funds invest in debt instruments with maturities of up to three years. The fund managers invest in a variety of debt instruments such as government securities, corporate bonds, and treasury bills. The main benefit of investing in a short-term bond fund is that it offers relatively high liquidity compared to other fixed-income options such as long-term bonds or FDs (fixed deposits).

7

Medium Duration Funds

Medium-duration funds are a type of mutual fund that invests in debt instruments with maturities of three to four years. These funds are considered to be less risky than long-term debt funds, but more volatile than short-term debt funds. Medium-duration funds offer higher returns than short-term debt funds, but with more risk.

Investors who are looking for stability and moderate returns may consider investing in medium-duration funds. The average return for this is around 7%; however, a savings account with FreoSave can give you the same return without putting your money at risk.

8

Medium to Long Duration Funds

Medium to long-duration debt funds invests in securities with a maturity period of 4 to 7 years. Such funds carry high-interest rate risk, and can be a good choice when the economy is doing well, and the interest rates are falling.

9

Long Duration Funds

Long-duration funds are mutual fund schemes in long-term government bonds and other debt instruments with maturities of 10 years and above. The primary objective of these funds is to generate income for investors through interest payments on the underlying investments.

Long-duration funds are relatively less volatile than other debt mutual fund schemes, making them ideal for risk-averse investors seeking stability in their portfolios. However, these funds also come with certain risks, such as the interest rate risk associated with long-term bonds. Nevertheless, long-duration funds can be a valuable addition to any investor’s portfolio, especially if held for the long term.

10

Dynamic Bond Funds

As the name suggests, dynamic bond funds are the funds in which your fund manager keeps changing your portfolio based on the fluctuating interest rate. Dynamic bond funds can have different maturity periods because they usually invest in instruments of both longer and shorter maturity periods.

11

Corporate Bond Funds

Corporate bond funds are like the debtors with the best possible credit rating. Companies with this high of a rating are financially strong and have a high probability of being able to pay back their lenders on time. These types of funds are ideal for people who don't need the money for at least 2 to 3 years. They often times outperform bank fixed deposits that have similar durations, and if you hold them for three or more years, you get tax-efficient returns since they qualify for indexation benefits.

12

Credit Risk Funds

A Credit risk funds are designed to take on higher levels of risk than other types of funds. The goal is to maximise your return while minimising the amount of credit you need to invest. These funds invest in debt securities of companies with a lower credit rating. Credit risk funds invest in subprime and leveraged loans, which are secured by collateral such as real estate, vehicles and other assets. These loans are more likely to default than companies with better ratings.

The main advantage of investing in credit risk funds is that it provides diversification benefits over standard bond funds. It also offers the opportunity to earn higher returns than fixed-income investments such as bank deposits and cash reserves.

13

Banking and PSU Funds

Banks and public sector undertakings (PSUs) are the two most important types of investment funds. Banking debt funds invest primarily in medium-term time deposits with banks. Time deposit refers to money deposited for a specific period of time at a fixed interest rate that does not change after it has been deposited. This means that even if interest rates go down, your money will still earn the same interest rate until the maturity date of your deposit note.

On the other hand, PSU bond funds invest primarily in short-term notes issued by the government or public sector enterprises (PSEs). Both types of debt funds have their benefits but may not be suitable for everyone.

14

Gilt Funds

Gilt funds are a type of debt fund that invest in gilts or bonds issued by the government. Gilt funds typically invest in various gilt issues and can be used to help diversify an investment portfolio. They have the advantage of being relatively low risk and are suitable for those with a limited appetite for risk but still want to participate in the equity markets.

Gilt funds are generally very liquid funds with regular reviews and trade throughout the day on a secondary market. They can also be bought and sold directly from your broker's website.

Gilt funds are usually considered appropriate for investors with moderate risk tolerance and various bonds available to suit your requirements.

15

Gilt Funds With 10-Year Constant Duration

Investment vehicles that invest in securities by the Reserve Bank of India are known as the Gilt Funds. As the name suggests, a gilt fund with a ten-year constant duration comes with a fixed maturity period of 10 years, and it is meant for people who have lower risk tolerance.

16

Floating Rate Funds

Floating rate funds have a floating rate of interest. This means that the interest paid by the fund is never fixed. Instead, it changes according to market conditions and other factors. Floating rate funds are popular because they offer the flexibility to invest in a wide range of investments without any restrictions on their interest rate.

The main benefit of floating rate funds is that you can use them for short-term investment purposes. This means you can use them for saving or even investing in emergency funds.

Things to Consider Before Investing in Debt Funds

Debt funds are a good investment if you have a cash surplus, but there are some things to consider before investing in debt funds. Many factors can affect the value of a debt instrument and its interest rate.

The riskiest debt instruments tend to be government bonds, which often have negative real yields (the return on an investment minus inflation). However, there are a number of other risks that investors take when investing in debt funds:

1

Credit Risk

Credit Risk

If the issuer of a debt instrument goes bankrupt, creditors will face losses. This risk is exceptionally high if the issuer has been issued bonds by governments, who often have less financial stability than private companies or companies in other sectors such as utilities or telecoms.

If the issuer of a debt instrument goes bankrupt, creditors will face losses. This risk is exceptionally high if the issuer has been issued bonds by governments, who often have less financial stability than private companies or companies in other sectors such as utilities or telecoms.

Financial Protection

A savings plan can help you manage your family’s finances better and prevent unforeseen expenses. If you have a savings plan, you will know how much money is available for emergencies or unexpected costs. This will also help you plan for the future and invest wisely for your retirement.

2

Default

Default

If a company fails to repay its debts, its bondholders may lose all or part of their investments. However, some issuers have limited recourse against their bondholders in the event of bankruptcy if they don’t meet certain minimum requirements, such as having sufficient cash reserves and being able to pay interest on time.

If a company fails to repay its debts, its bondholders may lose all or part of their investments. However, some issuers have limited recourse against their bondholders in the event of bankruptcy if they don’t meet certain minimum requirements, such as having sufficient cash reserves and being able to pay interest on time.

3

Trading Costs

Trading Costs

Debt funds charge trading costs that can be costly if you don’t have a good exit strategy at hand when the time comes to sell your shares or redeem your fund shares. To avoid these costs, you need to implement a systematic exit strategy before redemption begins so that you can get back what you invested and then some more.

Debt funds charge trading costs that can be costly if you don’t have a good exit strategy at hand when the time comes to sell your shares or redeem your fund shares. To avoid these costs, you need to implement a systematic exit strategy before redemption begins so that you can get back what you invested and then some more.

Retirement Planning

A savings plan can help you manage your family’s finances better and prevent unforeseen expenses. If you have a savings plan, you will know how much money is available for emergencies or unexpected costs. This will also help you plan for the future and invest wisely for your retirement.

FAQ

Which debt fund is the best?

Which debt funds are safe?

Is it good to invest in debt funds?

How do I choose a debt fund?

Which debt fund is the best?

Which debt funds are safe?

Is it good to invest in debt funds?

How do I choose a debt fund?

Which debt fund is the best?

Which debt funds are safe?

Is it good to invest in debt funds?

How do I choose a debt fund?

Not sure about investing in debt funds?

Freo’s digital savings bank account can also earn you great interest.

Freo’s digital savings bank account can also earn you great interest.

Freo’s digital savings bank account can also earn you great interest.

Freo offers you up to 7% interest depending on your balance, which is close to the interest you can earn by investing in debt funds. Plus, on opening a savings account with Freo, you can get access to the Freo debit card, which allows you to earn cash back and reward points on every spend. Keeping your money secured with a Freo savings account will also help you eliminate taxes that are charged from the gains you make with debt funds. You also get other benefits that are associated with Freo.

Open your Freo digital savings account today

Open your Freo digital savings account today

Start earning on your capital without risk.

Start earning on your capital without risk.