All You Need to know about Debt Mutual Funds

Debt Mutual Funds

Debt Mutual Funds

What is Debt Mutual Funds?

Debt mutual funds are investment schemes that hold bonds and other money market instruments. The best debt mutual funds in India go for highly rated securities that are safe and yield good returns. The return from these securities is interest income and capital appreciation that gets reflected in the debt mutual fund’s NAV.

Investors often misunderstand debt funds as fixed return yielding instruments. This is not true, even though a debt fund’s portfolio consists of fixed income securities.

Where Does the Debt Mutual Funds Invest?

Debt mutual funds invest in debt securities, listed and unlisted. They later sell them at a margin (appreciated price).

There are a plethora of debt instruments available differing based on their:

  • Issuer
  • Face value
  • Market value
  • Tenure
  • Yield

The debt mutual funds are categorized based on these features.

Types of Debt Mutual Funds

Below are mentioned various types of debt mutual funds and their categories. Go through all these.

  • Liquid Fund

    • Short-term investment
    • Invest in instruments with less than 90 days maturity. ( T-bills, Commercial Paper, certificate of deposit, etc.)
    • Ideal for an emergency fund
    • A better substitute for a savings bank account
  • ‘Ultra Short-term Bond’ Fund

    • Better returns than liquid funds
  • Short-term Income Funds

    • Holds debt securities 1-3 years maturity
    • Medium-term investment horizon (1 year or less)
  • Fixed Maturity Plans

    • Close-ended fund
    • Predetermined maturity date
    • Passively managed
    • Invested securities are held till maturity
    • The investment horizon of 3 years
    • A better alternative to Bank FDs
  • Long-term income Funds

    • Holds securities with 3 to 10 years maturity
    • For medium to the long term investment horizon
  • Guilt Fund

    • Invests in government securities with 3 to 20 years of maturity
    • Minimal credit risk, no risk of default
    • Available with short-term and long-term maturity
  • Monthly Income Plans

    • Hybrid scheme
    • Invests in debt and equity
    • Have regular dividend payouts
  • Capital Protection Oriented Funds

    • Closed-ended fund
    • Invests majorly in AAA-rated bonds
  • Dynamic Bond Fund

    • Actively managed
  • Credit opportunity Funds

    • Invests in lower-rated debt securities

Benefits of Investing in Debt Mutual Funds

  • Low cost of investing
  • Liquid
  • Stabilized returns
  • Indexation benefit

Who Should Invest in a Debt Mutual Fund?

Debt mutual funds are best suited for investors:

  • Looking for regular fixed income
  • Who wants to keep distance from risk
  • Who is bothered about capital preservation,
  • Who wants to park capital for short-term,

Compared to the term deposits- that offer low-interest rates- the best debt mutual funds in India help yield better returns.

  • Risk

You automatically lower your risk by investing in the best debt mutual funds in India.

Debt mutual funds are associated with interest rate risk.

The bond prices and interest rates are inversely related. Thus the change in interest rate affects the NAV too. An increase in interest rate will push the NAV down and vice versa.

Another risk possessed by debt instruments is credit risk. The borrower can default on interest payment and capital repayment.

The fund managers of the best debt mutual funds in India make sure they wisely select top credit rated debt securities.

  • Returns

As a mutual fund investor, you earn returns in terms of NAV and dividend (if you opt for it).

The fund, however, earns through interest and sale of the security. The NAV is calculated after considering this income and the expenses incurred by the scheme (cost of buying the security/ initial investment, other expenses to manage the fund).

Average return by different types of debt mutual funds

Type of debt mutual fund

Returns (%)

Bank & PSU


Liquid Funds


Ultra Short


Corporate Bond


Govt. Sector


The Net Asset Value (NAV) of a debt fund is calculated as the ‘market value of the securities in the portfolio minus the expenses’.

Market value

Because the market value of the debt securities change, the NAV also fluctuates. It is, however, more stable than an equity fund.

The price of the debt securities change due to various factors:

  • Economic conditions
  • Demand and supply
  • Interest rates
  • Expense ratio

One major boon of investing in debt mutual funds is its low-cost structure. The expense ratio of debt funds is low compared to active equity schemes.

The fund’s expenses and the expense ratio are important components in mutual fund investing. Moreover, in a debt fund, investors should evaluate and make sure that the expenses of the fund don’t eat up your subdued returns.

A major expense for a mutual fund is the fund manager’s fees or the management fees. SEBI has capped this to 2.25% of the asset under management.

Other costs include administrative and distribution expenses of the scheme.

  • Taxation

If you have opted for a dividend fund, the dividend income from the debt fund is not taxable. However, a 28.325% Dividend Distribution Tax is deducted at the fund’s end.

Long-term capital gain income from debt mutual funds is taxable:

  • 10% (without indexation)
  • 20% (with indexation)

The short-term capital gains are taxable based on the income tax slab one falls under.

Note that in an STP, if you transfer funds from a debt fund to another Mutual Funds, three years is considered as short-term. Your fund 1 is a debt fund and goes for an STP within three years- short-term capital gain is levied.

  • Indexation

Indexation is a method to adjust the purchase price of your investment and lower the overall tax liability. This method may not be suitable for investors who fall under the lower tax bracket.

Stay invested in the best debt mutual funds in India for a longer term to lower the expenses and get indexation benefits.

How to Select Debt Mutual Funds?

  • Take a close look at the best debt mutual fund’s asset allocation. In debt mutual funds, you can get an idea of expected returns.
  • Check average maturity of the underlying securities.
    • Low maturity period: low volatility
    • Long maturity: more volatile
    • More volatility in debt funds is good when you have a long-term investment horizon.
  • A fund stacked up with corporate debt instruments will be less liquid. It cannot cater well to short-term goals. In times of redemption pressure, the fund manager will have to exit such liquid securities at a loss, thus affecting the NAV.
  • Unlike equity mutual funds, it is advised to avoid small debt mutual funds. Suppose one big investor holds a sizable portion of the fund, his/her exit will impact the overall fund’s performance.
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