HomeFINANCEDebt Mutual Funds Are Safer Investment Option?

Debt Mutual Funds Are Safer Investment Option?

A Loan is when you borrow a certain principle amount from the bank. You pay back certain interest on the principal to the bank from time to time. At the end of the time period, you pay back the full principal amount to the bank. Similarly, companies issue Bonds to customers. Buying a company’s bonds is like giving a loan to the company. The company pays back interests on that bond to the customer. Selling bonds and shares are the two ways a company can raise funds. Equity Mutual Funds is buying the company shares in this case. While Debt Mutual Funds is buying the company bonds.

What are Debt Mutual Funds?

Debt Mutual Funds is when you buy a company’s bonds. Debt mutual funds are usually into investing in fixed-interest generating securities. These are usually government securities, commercial papers, treasury bills, corporate bonds, etc. Investing in a debt mutual fund gives interest income and capital appreciation in return. The interest rate is decided at the time of the bond issue. The bonds also have a maturity period and do not go on forever. Thus, bonds are also known as fixed-income sources of money.

Similar to how share prices rise and fall in the share market, bond prices too rise and fall during market hours. So, if you buy a company’s bond at Rs 100 today which falls to Rs 80 tomorrow, then it will be considered that you have loaned the company Rs 80 only. Alternatively, if the bond price goes up to Rs 150, then you have loaned Rs 150 to the company. But since the interest rate is fixed, your interest on the bond will not suffer.

Why do the price of bonds change?

The interest rate of bond remains constant for the ones the company has already sold. But the new bonds which the company issues can be sold at a higher or lower interest rate. This interest rate is related to the economy of the country as well. If the economy is weak, the interest rate will be low and vice-versa. An important point to note here is that if the interest rate is high, the bond price will be low. Conversely, if the interest rate is low, the bond price will be high.

How do Debt Mutual Funds work?

Suppose you made a SIP of Rs 1000, which buys a collection of bonds at differing rates of interest. This collection of bonds is known as mutual funds. The price of one unit of the mutual fund is called NAV (or Net Asset Value). If the average interest you receive from the collection of bonds increases then your NAV decreases. If the average interest rate decreases, then the NAV will increase. This will lead to a profit and interest income upon selling the bonds at this moment.

Sometimes company may offer a high interest rate for their bonds. One has to be cautious while buying such company bonds. Since usually the company’s bonds may not be selling because the company’s credit ratings may be bad. This means that the company has defaulted in paying the bond interests in the past. One must be aware of such situations while buying debt mutual funds.

Types of Debt Mutual Funds

Short-term debt funds

These are liquid funds which can be easily and quickly sold off and converted to cash. Their returns range between 7-9%. They are a better option than saving bank account since their return is only 3-4%. Liquid funds mature within 91 days generally are hardly ever suffer a loss.

Medium-term debt funds

Compared to your five year FDs, medium-term debt funds offer higher returns. They also give you a regular interest income for long-term. For more details on medium-term debt funds click here.

Some more extensions of debt funds:

Dynamic funds

Here, the fund manager keeps changing the portfolio compositions on the basis of the fluctuating economy interest rate. These have a different average maturity period since they take interest rate calls and invest in instruments of short and medium-terms.

Income funds

Income funds take a call on the interest rates and invest predominantly in debt securities with long maturity periods. This makes them more stable than dynamic bond funds. The average maturity of income funds is around 5-7 years. null

Short-Term and Ultra Short-Term Debt Funds

These are debt funds that invest in instruments with short maturity periods ranging between 1 to 3 years. Short-term funds are ideal for less risk-taking investors as these funds are not affected by interest rate movements.

Gift Funds

Gift funds invest in only government securities which are generally high-rated securities with very low credit risk. Since the government seldom defaults on the loan it takes in the form of debt instruments; gift funds are an ideal choice for risk-averse fixed-income investors.

Credit Opportunity Funds

Credit opportunity funds do not invest according to the maturities of debt instruments. These funds try to earn higher returns by taking a call on credit risks or by holding lower-rated bonds that come with higher interest rates. Hence, they are relatively riskier debt funds.

Fixed Maturity Plans

Fixed maturity plans are closed-ended debt funds. These funds also invest in fixed income securities like corporate bonds and government securities. They have a fixed time period for which your money will be locked-in. This period can range from a few months to years. However, you can invest only during the initial offer period. It is like a fixed deposit that can deliver superior, tax-efficient returns but does not guarantee high returns.

debt mutual funds

Always check the expense ratio before buying any mutual funds.

Check the video on this topic below.

Also read, How Stock Market Works | Why Do Share Prices Rise & Fall?

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Heena Siddique
Heena Siddique
Bibliophile. Turophile. Foodie. Tea enthusiast. Shopaholic. Sitcom addict. Movie buff.

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