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Thursday 1 October 2020
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A Basic Guide to Debt Funds in India

A Basic Guide to Debt Funds in India

The corporate debt funds market had grown from ₹14.4 lakh crore in 2014 to ₹30.6 lakh crore by June 2019, according to RBI figures. The main objective of debt funds is to offer a steady income throughout the investment period. This is the reason that fund managers invest in securities with different interest rates to create a well-diversified portfolio.

What are Debt Funds?
Debt mutual funds are a type of mutual funds that invest in fixed income instruments like bonds, debentures, treasury bills, government securities and commercial papers. This represents a way of lending money to private entities and government bodies, with the aim of earning interest and benefiting from capital appreciation. Low cost structure, high liquidity, steady returns with lower volatility and safety are some benefits of debt mutual funds. These funds are best suited for those who have low risk appetite.

Things to Know Before Investing in Debt Funds
In order to make an informed and smart decision, consider the following:

Returns
Debt funds or fixed income mutual funds might be known for generating steady income, but returns are not guaranteed. In the debt market, bond prices can rise and fall. If you invest in a bond and its price rises continuously, it may generate more money than what it would have generated from the interest rate. This additional value is capital appreciation. However, a change in interest rates can cause prices to decline.

Risk
There are two types of risks involved in debt funds. These are interest risk and credit risk. The interest rates of the underlying securities may rise or fall. The longer the tenure of the bond held, the higher is the risk when interest rates fluctuate. This is because the price of the bonds or instruments and the rates of interest are inversely proportionate. Credit risk entails the risk of losing the interest and the principal.

Tenure
Fixed income mutual funds are good for investors looking for medium- or short-term investments. This is because they tend to fluctuate within a range and do not offer the kind of appreciation as equity funds can. This makes them a smart choice for investors who are risk averse and looking for some income in the near term. In case you stay invested for a long term, chances are you will not gain the desired capital appreciation. Investors with longer-term horizons typically prefer equity funds.

Financial Objective
Keeping in mind your financial goals, you can opt for debt mutual funds to generate an extra income stream. While post retirement you can invest in debt funds to supplement your pension, new investors can invest in them for liquidity. However, it’s good to educate yourself of the risks before entering the market.

Ultimately, ensure you have defined your long-term goals, how much risk you can bear and for how long you want to stay invested, to leverage the potential of income mutual funds.