A Complete Guide for Investing in Debt Funds

As written on 16^th Feb 2021

Mutual funds are categorized by market regulator SEBI to help investors take an informed investment decision. Equity, debt, hybrid, solution-oriented, ETF and gold are just a few of the several other categories available for investing. Depending on your risk appetite, investment objective, investment horizon and existing liabilities, you can decide how much money you want to invest for targeting your financial goals. It is almost impossible to gain wealth with mutual fund investments over the short term. However, if you want to park your money for the short term or are looking for an investment scheme that might offer stable returns with low investment risk, you can consider diversifying your investment portfolio with debt mutual funds.

Debt mutual funds are open ended schemes that invest in fixed income securities that generate regular income. Debt funds invest in debt related instruments like call money, certificate of deposits, debentures, derivatives, company fixed deposits, commercial papers, government securities, etc. They invest in debt instruments and earn income through interest. Every debt scheme has an underlying benchmark which it aims to outperform. It is the responsibility of the debt mutual fund manager to come up with an investment strategy that might help the scheme perform, and in the process, help its investors earn some capital appreciation.

Types of Debt Funds

Liquid funds – A liquid fund invests in marketable securities that come with a maturity period of up to 91 days. These are ideal for building an emergency fund.

Dynamic bond – A dynamic bond fund follows an investment strategy where it switches between long-term to mid-term to short-term securities depending on market conditions.

Corporate bond fund – A corporate bond scheme primarily invests in highest rated corporate bonds for income generation.

Ultra short duration fund – Ultra short duration funds invests in debt and money market instruments such that the Macaulay duration of the portfolio is between 3 months and 6 months.

Low duration fund – Low duration fund invests in debt and money market instruments such that the Macaulay duration of the portfolio is between 6 months to 12 months.

Overnight fund – An overnight debt fund is an open ended scheme that invests in overnight securities.

Money market fund – A money market fund invests in liquid instruments such as commercial paper, high credit rating debt-based securities, treasury bills, cash and cash equivalent securities, which have a maturity of up to 1 year.

Short duration fund – A short duration fund is an open ended short term debt scheme which invests in Debt & Money Market instruments such that Macaulay duration of the portfolio is between 1 year and 3 years.

Medium duration fund – Medium duration funds invests in debt and debt related instruments such that Macaulay duration of the portfolio is between 3 years and 4 years.

Medium to long duration fund – This an open ended debt fund which invests in debt and money market instruments such that the Macaulay duration of the portfolio is between 4 and 7 years.

Long duration fund – Of its total assets, a long duration fund must invest in debt and money market instruments such that the Macaulay duration of the mutual fund portfolio is longer than 7 years.

Gilt fund – A gilt fund is a type of a debt fund that must invest 80 percent of the total assets in government securities.

Floater fund – Of its total assets, a floater debt fund must invest a minimum of 65% in floating rate debt instruments.

Credit risk fund – In order to meet its investment objective, a credit risk fund must invest a minimum of 65% in below highest rated corporate bonds of the total assets.

Banking and PSU fund – A banking and PSU fund must invest a minimum of 80% of its total assets in debt instruments of banks, public sector undertakings, and public financial institutions.

Start a SIP or make a Lump Sum investment in debt funds

You can either make a one time investment in debt funds or opt for systematic disciplined investing through SIP. A lump sum investment must be made right at the beginning of the investment cycle. On the other hand, if you wish to inculcate the discipline of regular investing, you can consider starting a monthly SIP. A Systematic Investment Plan is an easy and hassle-free way to invest in debt funds. Investors can also refer to a free online tool like SIP Calculator to determine the approximate capital appreciation that they might earn at the end of their investment journey. SIP is an ideal way to gradually grow your debt fund corpus. The more you invest, the higher your chances are of achieving your targeted financial goals. The monthly SIP sum which an investor decides cannot be lesser than the minimum investment amount mentioned in the offer document. If you do not redeem your debt fund units and allow reinvestment, your money has the potential to multiply over the long term, thanks to the power of compounding.

Invest in debt funds once you have spoken to your financial advisor.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.