What Is Debt Mutual Fund, And How To Select? Should You Invest In 2022?

A mutual fund invests the investors' money in multiple funds or stocks to diversify the risks of losses. Depending on the funds' and stocks' performances, the mutual funds offer upside. There are multiple types of mutual funds, like ELSS (tax savings), equity focussed and debt funds. This article will explore the various scopes and fields of debt mutual funds.

What is a debt mutual fund?

A debt fund is a kind of mutual fund, which will invest your money in different types of fixed income tools like Corporate and Government Bonds, corporate debt securities, and equity market instruments, to offer you the best possible return from the fund. The debt funds have a low-cost structure. You can invest in lump sum amount in the debt mutual funds or also can systematically transfer by small portions.

To understand the debt mutual funds, you need to know the corporates' or governments' debt issues. Often the corporates and the government take loan from common people and assure them that they will get the money back with a pre-decided interest rate, after a certain period. So, the common people here can act as investors for the corporates or government, and become the money lender to them. So, you can earn assured money after the decided period, with interest.

Why is a debt mutual fund better secured than equity focussed funds?

Debt funds are often identified as fixed-income funds or bond funds. A fixed-income fund means your invested money is quite assured and secured in the mutual fund. These funds give relatively stable returns, are less volatile, and most have higher liquidity. But why so? The returns from the equity focussed funds are linked directly to the performance of the stocks in the equity markets. If the company performs well, your returns will be considerably good, and vice versa. But the debt mutual funds By investing in debt funds will assure the returns. So, you can diversify the investment portfolio to mitigate the risk quotient.

However, the returns from debt mutual funds are not completely guaranteed, and these are subject to market risks. A rising interest rate will leave a positive impact on your returns, and vice versa. There are short-term debt mutual funds for 1-3 years, long-term debt mutual funds for more than 5 years. Often analysts say that the short-term debt mutual funds are safer because the returns will not be much impacted by the change in interest rates. In the case of the long-term funds, it will be different, which is referred to as interest rate risk. Hence, the debt mutual funds are suitable for investors with a moderate risk appetite.

Comparison of debt mutual funds with FDs

Considering these factors, the debt mutual funds were used to be compared with regular banks deposit schemes like fixed deposits (FDs). The bank or post office FDs also provide assured income after a certain period. However, the RBI has kept the interest rate at a historically low level since the last year. So, the returns from the assured deposits schemes are very low now.

Earlier, the bank or post office FDs used to give around 8-9% returns, but now the FDs are offering around 5-6% returns. On the other hand, good long-term debt mutual funds are giving around 8% returns. So, if you are keen on assured income with good returns, you can consider debt mutual funds, rather than FDs. Debt mutual funds offer much lower returns than equity mutual funds, but as mentioned earlier, these are much safer than them. So that you can meet your financial goals.

Tax efficiency

In a debt mutual fund, you can earn money in a better tax-efficient manner. For the debt mutual funds, you will have to pay the tax in the year you redeem your money. Before that, you are not required to pay the tax. As usual, like for other funds, if you hold your debt mutual fund position for less than 3 years, you will have to pay Short Term Capital Gains (STCG) tax. On the other hand, if you hold your debt mutual fund position for more than 3 years, you will have to pay Long-Term Capital Gains (LTCG) tax. For the LTCG or long-term investment, you will be eligible for indexation benefits, which will be embedded in the cost inflation index (CII).

To invest in debt mutual funds, an investor needs to invest through any Asset Management Company (AMC). To select the best fund, you need to follow the AUM and returns from the funds, both in the long and short term.