Introduction To Debt Funds

By BankBazaar | October 10, 2016

Introduction To Debt Funds

Many people have countless questions when it comes to investing. The main stumbling block with investments is the uncertainty over returns and the fear of financial losses.

But wait. If you are wary of financial uncertainties and are not comfortable with risks on your investments, there is a solution. Let us tell you all about it, shall we?

Meet Debt Funds

If you are uncomfortable with the effect of market risks on your investments, you will probably be looking for a more stable investment option. Right? Enter Debt Funds.

Debt Funds? What’s That?

Debt Mutual Funds are a type of Mutual Fund that investors can choose to invest in if they are looking for a safer investment alternative to higher risk Mutual Funds such as equity Mutual Funds.

Debt Funds invest in money market instruments like certificates of deposit, government securities, debentures and corporate bonds.

Risk level of Debt Funds

As Debt Funds do not invest in stock market securities like Equity Mutual Funds, they offer investors rather predictable returns. Debt Funds are therefore considered as low-risk investments.

Types of Debt Funds

There are different types of Debt Mutual Funds. We shall tell you about the four most common types, all right?

General Debt Mutual Funds

These Debt Funds are the regular Mutual Funds that invest in different debt instruments for varying tenures. Some types of general Debt Funds are certificate of deposits, bonds and debentures.

Additional Reading: Top 3 Short-Term Investment Options

Monthly Income Plans

Monthly Income Plans are a type of Debt Fund that give investors a regular payout through dividends. An investor can choose to get these dividends on a monthly, quarterly, semi-annually or on an annual basis. Monthly Income Plans generally invest a large portion of the investment fund in debt instruments, while a smaller portion is invested in equity.

Hey! Don’t get mixed up between Monthly Income Plans and Post Office Monthly Income Schemes. They are very different.

Remember, dividends on the Monthly Income Plans are paid to investors at the discretion of the fund. These payments are not mandatory.

Gilt Funds

Gilt Funds are a type of Debt Mutual Fund that have investments primarily in long-term government securities like government bonds.

Here’s a word of caution. Gilt Funds may seem like the safest type of Debt Fund. However, remember that the returns on Gilt Funds can see a lot of variation. For instance, a regular Gilt Fund can vary by 2.5% over six month period, 16% annually or 9% in 5 years.

As a result, Gilt Funds are not usually recommended for regular, beginner investors.

Check This: Investment Options For Everyone

Liquid Funds

Liquid Funds are Debt Funds that have a short maturity period. Liquid Funds invest in short-term debt instruments like Term Deposits and treasury bills, among others. Liquid Funds usually have an investment tenure of 3-6 months.

Returns on Debt Mutual Funds

Debt Mutual Funds give investors mediocre returns of 7-9%, similar to the returns offered on Fixed Deposits. But before you decide to choose a Fixed Deposit, we can tell you why you should invest in Debt Funds rather than in a Fixed Deposit.

Read More: Why Debt Funds Are Better Than Fixed Deposits

Benefits of investing in Debt Mutual Funds

  • Debt Funds are a more lucrative investment option compared to Fixed Deposits because Debt funds are more tax-friendly.
  • Debt Funds are a good investment option to consider if you have time-sensitive and non-negotiable financial goals to achieve. Absolutely need that new car in one year? Salt away the money in a Debt Fund to pay for it.

You can invest in a mix of Equity Mutual Funds and Debt Funds to bring a degree of stability to your investment portfolio. This is critical, especially during a period of market volatility.

Understanding the difference between Equity Mutual Funds and Debt Mutual Funds

Mutual Funds, as we all know by now, are a very profitable investment option for investors looking for good returns, whether they are being adventurous or conservative with their investment portfolio.

Did you think Debt Mutual Funds and Equity Mutual Funds are equally risky? Let us tell you all about the difference in the risk exposure between Debt Mutual Funds and Equity Mutual Funds.

Where do Debt Funds invest?

As we have read in the beginning of this article, Debt Funds invest in government securities, corporate bonds and money market instruments like treasury bills.

As a result of these conservative avenues in which Debt Funds invest, the growth of your investment in Debt Funds is comparatively slower than the growth of value of Equity Mutual Funds.

If you are looking to get steady returns on your investments, choose to invest in Debt Mutual Funds.

Where do Equity Mutual Funds invest?

Equity Mutual Funds are an ideal investment option for investors looking for long-term wealth creation and high potential returns. Equity Mutual Funds, as the name suggests, invest primarily in equities or stocks.

If you are investing for the short term, you must know, Equity Mutual Funds are considered high-risk investments for short-term goals because the performance of these funds are dependent on market volatility and markets deliver returns only in the long-term.

Understanding risk exposure

Equity Mutual Funds and Debt Mutual Funds have different risk profiles.

  • Equity Mutual Funds

As Equity Mutual Funds invest mainly in company stocks, the returns gained are linked to the prevailing market trends. If you are looking for a long-term investment that beats inflation, Equity Mutual Funds are for you. But, you must be prepared to accept the risks that come with investing in equities. By remaining invested for the long term, you can gain higher inflation-adjusted returns. The magic of compounding works on your invested corpus.

Read This: Understanding Systematic Investment Plans

  • Debt Funds

Debt Funds offer investors a steady income and have a relatively lower risk exposure when compared to Equity Mutual Funds. If you are looking to generate a regular income, look no further than Debt Funds. But you must be ready to settle for mediocre returns on your investments in Debt Funds.

The BIG question: Equity or Debt?

There are several factors to consider when you think of investing in Mutual Funds. Choose the type of funds carefully after assessing your risk tolerance with your finances. Are you comfortable with volatile returns or do you prefer steady, lower returns and a certain degree of safety for your invested capital?

It is important to select Mutual Funds based on fund performance and official fund reports, rather than relying on personal choice, brands and uninformed recommendations from friendly advisors. Take professional investment advice.

Safety in diversification

As we mentioned when we told you about the benefits of investing in Debt Funds, you can gain tremendously from diversifying your investments. To get the benefits from both equity and debt, you can consider building a well-diversified investment portfolio. This mix in your investments, between equity and debt, will offer you less volatile returns. This is because the debt investment component in your portfolio will act as a cushion against the uncertainties in the equity markets.

Make a wise choice today. Reap the rewards of intelligent investing.

Read More: What To Consider When Choosing The Right Debt Funds

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