Debt Mutual Funds are a mixture of debt or fixed income securities. Debt mutual funds offer several advantages, though these days we are seeing a trend of very few small investors investing in debt mutual funds.
Here are reasons to invest in debt mutual funds:
A good merit of the debt fund is liquidity. We can withdraw the investments at any time, and the money is in your bank account the next day. The fund house does not levy a penalty for exiting too soon. Most debt funds don't levy a charge if the investment is redeemed after one month. You can also make partial withdrawals, without having to break the entire investment. Do check the exit load before investing.
Debt funds offer a wider variety for a short period. Ultra-short-term bond funds are suitable for a 3-month to 1-year period. Investors can consider short-term bond funds for a 1-2 year horizon, medium-term funds for 2-3 years and long-term funds for 3-5 years. Risk and return will be higher for longterm funds.
Debt funds contain a wide array of securities to reduce the amount of risk in the fund. Diversification of investments prevents events that affect one sector from affecting an entire portfolio. It make large losses less likely. Diversifying via debt funds reduces the overall portfolio risk.
Debt funds are also more flexible than fixed deposits. You can invest small amounts every month by way of a SIP or whenever you have surplus cash. This is particularly useful for retirees who want a fixed income every month.
This is the major reason to consider a debt mutual funds. For the long term, debt funds are far more tax efficient than fixed deposits. In debt funds, only the change in net asset value is taxed.
Debt funds give more than fixed deposits and the savings bank account. The gains get taxed at the same rate if the investment is for less than three years. If there are changes in interest rates, your debt fund could give higher returns. Short-term debt funds are not affected too much by rate changes.