What are debt mutual funds?
Debt mutual funds are schemes that invest in a mix of instruments such as corporate/government bonds, corporate debt securities and money market instruments. Depending on the scheme, the portfolio can have one of the above securities or a mix of them.What options are available in debt funds?
There are a variety of fixed-income schemes meant for investors looking to allocate money for as little as a day or for those looking to benefit from rate cuts. There are various categories of debt funds investors can choose based on risk appetite and investment horizon. Investors with a short-term time frame of one day to three months can use overnight/liquid funds; those with a time frame of three months to a year can use ultra-short-term funds; those with a time frame of 1-3 years can use short-term or medium duration funds and corporate bond funds. Investors looking to capitalise on a fall in interest rates and earn a capital appreciation can use long-tenure Gsec funds that have a maturity upwards of five years, while those eyeing visibility of returns can choose a target maturity fund.
How does a debt fund earn a return?
A debt scheme earns a return for investors in two ways. One, they get interest income, which generates accrual income. Second, as and when interest rates fall/rise, bond prices move up/down, resulting in capital gains/losses. Both the gains combined together are the final return to the investor. The capital gain/loss component is also called the mark-to-market (MTM) return.
What advantages do these funds offer?
Debt funds are highly liquid. A redemption request once placed before the cut-off time, ensures money comes into your bank account on the next working day. Investors can switch between various debt schemes at times based on changing requirements. In a fixed deposit, if you needs money in an emergency, you need to break the full deposit, while in a debt fund, you can redeem only the required number of units or amount. Most banks levy a penalty on fixed deposits if withdrawn before the maturity date, while there is no such penalty in debt funds. When interest rates begin to fall, there is a scope for capital appreciation, which does not exist in other fixed-income products. Investors can redeem small amounts that are highly liquid. Investors also book profits in equities and park money in debt funds to return to equities when valuations turn cheaper.How are debt funds taxed?
Debt mutual funds are taxed like other fixed-income products. The capital gains earned from such schemes are taxed as per the slab rate applicable to the individual, and no long-term capital gains or indexation benefits are available.
