Debt mutual funds offer numerous advantages to investors.

• High liquidity

Debt funds are highly liquid and can be redeemed easily in case of a financial emergency by placing a simple redemption request. Since there is no lock-in period involved in debt funds, you can, you can convert them into cash very quickly.

• Low-cost investment

As per SEBI norms, the total expense ratio of a debt mutual fund cannot be more than 2% of the asset under management. Within the debt funds category, overnight and liquid funds are associated with notably low expense ratios, whereas dynamic and long-term funds come with higher expense ratios.

• Hedge against volatility

Debt funds are not much impacted by market volatility and hence can serve as an excellent hedge against market volatility and unpredictable market events.

• Low portfolio risk

Debt mutual funds carry lower portfolio risk and a strategic allocation can ensure stability to your investment portfolio. They are ideal for investors with low-risk appetite.

• Investors seeking Regular income:

  Debt funds that invest in high-quality bonds or keep durations low are ideal for risk-averse investors looking for steady income, such as retired persons.

• Conservative or First-time mutual fund investors:

  Conservative or first-time mutual fund investors, who do not want to take on the risk of investing in equity funds, can consider short duration funds or corporate bond funds, as a replacement for bank fixed deposits. Along with liquidity and flexibility of withdrawal, the debt fund investment is likely to generate higher returns, especially when interest rates are declining.

• Investors who want to purchase equity in a bearish market:

  Even an aggressive equity investor can benefit by combining a debt fund with a Systematic Transfer Plan (STP). For example, an STP from a debt fund to an equity fund will minimize average cost in a sideways or bearish market; because the STP will allow periodic transfers from the debt fund to purchase units of the equity fund.

• Investors who want to park short-term funds:

  Households and businesses can deploy short-term surpluses in liquid or ultra-short duration funds rather than leave them in a bank deposit. An overnight or liquid fund can even hold household emergency funds while earning a modest return. Investors with a specific investment horizon can opt for an FMP.

Debt funds can be categorised based on their maturity period. The following are the debt funds types:

• Money Market Funds

  Money market funds primarily invest in money market instruments with a maturity of up to 1 year. They are designed for investors who prefer low-risk debt securities with short-term maturities. They provide a relatively secure and stable investment option.

• Liquid Funds

  Liquid funds invest in Debt and money market instruments with maturity of upto 91 days only. They present a favourable option for short-term investments, as they generally offer higher debt funds returns compared to savings accounts.

• Dynamic Bond Funds

  Dynamic bond funds invest in debt instruments with different maturities, depending on the prevailing interest rate regime. They are well-suited for investors who have a moderate risk-bearing capacity and an investment timeframe of 3 to 5 years.

• Gilt Funds

  Gilt funds invest at least 80% of their assets in Government bonds of varying maturities. These funds do not carry credit risk but they are susceptible to high interest rate risk. These funds perform well in a falling interest rate environment.

• Banking and PSU Funds

  Banking and PSU funds invest a minimum of 80% of their portfolio in debt instruments issued by banks, PSUs, and public financial institutions. With moderate level risk, they provide an optimum balance between liquidity, yield and safety.

• Corporate Bond Fund

  Corporate bond funds invest a minimum of 80% of their total assets in AA+ or higher-rated corporate bonds. These funds are ideal for risk-averse investors seeking regular income and safety.

• Floater Funds

  Floater funds invest at least 65% of their portfolio funds in floating rate instruments such as certificates of deposit. They come with low interest rate risk and debt fund interest rates keep changing periodically.

• Credit Risk Funds

  Credit risk funds allocate at least 65% of their investible corpus in corporate bonds rated AA or below. Owing to this, these funds tend to generate slightly higher yields than the highest-quality bonds coupled with certain credit risk.

• Overnight Funds

  Overnight funds invest in 1-day maturity securities, mostly money market instruments. These funds tend to provide safety and liquidity rather than high returns. They carry negligible credit risk and interest rate risk.

• Ultra Short Duration Funds

  These funds invest in a combination of money market instruments and debt securities in such a way that the Macaulay duration of the scheme falls within the range of three to six months.

• Low Duration Funds

  These funds invest in a combination of money market instruments and debt securities in such a way that the Macaulay duration of the scheme falls within the range of six to twelve months.




• Short Duration Funds

  These funds invest in a combination of money market instruments and debt securities in such a way that the Macaulay duration of the scheme falls within the range of one to three years.




• Medium Duration Funds

  These funds invest in a combination of money market instruments and debt securities in such a way that the Macaulay duration of the scheme falls within the range of three to four years.




• Medium to Long Duration Funds

  These funds invest in a combination of money market instruments and debt securities in such a way that the Macaulay duration of the scheme falls within the range of four to seven years.




• Long Duration Funds

  These funds invest in money market instruments and debt securities strategically, targeting a Macaulay duration of over seven years.

Debt mutual funds typically carry the following risks:

• Interest Rate Risk

  - It refers to the impact of fluctuating interest rates on the value of the securities held within the scheme.




• Credit Risk

  – It pertains to the likelihood of the issuer defaulting on the repayment of both the principal amount and the interest.




• Liquidity Risk

  – It refers to the risk faced by the fund house when it lacks sufficient liquidity to fulfill redemption requests from investors.

You can invest in debt funds by following these simple steps:

• Login through App or website
  
  Download and install the app on your mobile device or visit the website to create a login/signup account.




• Select the desired debt fund
  
  Choose the debt funds you want to invest in by browsing or searching for them.




• Select investment mode
  
  Choose your preferred investment mode. You can invest in debt funds via lump sum or Systematic Investment Plan (SIP).




• Make payment and begin investing
  
  Make the payment securely using Net Banking or UPI and begin investing in the debt funds instantly.

The rate of tax on debt mutual funds is as follows:

On Redemption

Pursuant to amendment to the Finance Bill 2023, any capital gains earned on investments made in debt funds on or after 1 April 2023, will be considered as short-term capital gains and added to the investor’s income and taxed at the applicable income tax slab rates (plus any applicable surcharge and cess), regardless of the investment holding period.

Please note that investments made on or before March 31, 2023, and held for more than 36 months will be eligible for indexation benefit in taxation. Gains on such investments will be taxed at a rate of 20% (plus applicable surcharge and cess) after taking into account the indexation benefit.

On IDCW

Any income received under this option would be considered as income for the investors and hence would be taxed at applicable tax slab rates. Aditya Birla Sun Life AMC Limited /Aditya Birla Sun Life Mutual Fund is not guaranteeing/ offering/ communicating any indicative yield/returns on investments.

Here are some important aspects that you must consider before investing in debt funds in India:

Risks in Debt Funds

Debts funds fundamentally carry three types of risks:

1. Credit Risk - which is the default risk of the issuer not repaying the principal and interest.

2. Interest Rate Risk - which is the effect of changing interest rates on the value of the scheme's securities.

3. Liquidity Risk - which is the risk carried by the fund house of not having adequate liquidity to meet redemption requests.

Returns

Debt funds offer lower returns as compared to equity funds. Also, there is no guarantee of the returns. The NAV of debt funds fluctuates with changes in the interest rate. If the interest rates rise, then the NAV of a debt fund falls and vice-versa

Expense Ratio

This is an important aspect while investing in debt funds. The expense ratio is a percentage of the fund's total assets which a fee towards fund management services. Since the returns in debt funds are not very high, a high expense ratio can dent your earnings. Look for schemes with a lower expense ratio and stay invested for a longer-term.

Selecting the best debt fund will depend on your investment horizon. If you want to invest for 1 day to up to a month then opt for Overnight Funds or Liquid Funds. For up to 6 months, ultra-short Duration funds. For 6 months to 1 year time period. Money Market funds. and if the investment horizon is between 1 year and 3 years, you can go for corporate bond funds, Banking & PSU Bonds Funds, or Short Duration Bond Funds.