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What are Debt Mutual Funds? Meaning, Types, Benefits, Return & Taxation

What are Debt Mutual Funds? Meaning, Types, Benefits, Return & Taxation

The bank may levy an early withdrawal penalty or fee if the money is withdrawn too soon. When an account holder makes a fixed deposit, the amount of profit or interest earned on the investment is predetermined. Irrespective of changes in interest rates, the rate will not grow or reduce at any moment. The risk of default is minimal since these funds are guaranteed by government agencies such as the RBI. Debt funds are an excellent choice if you’re looking for a place to put your money where it will be safe.

They are considered to be less volatile than equity funds and are hence ideal for investors who are relatively risk averse and are looking for stability in their investments. Normally, investors can expect returns of around 5-8% from ultra-short duration funds. Ultra-short duration schemes which take some extra risk also have the potential to offer extra returns. These schemes have low impact from change in interest rate scenarios so doesn’t have high interest rate risk but may have an element of credit risk in them. It is very important that investor understand what kind of Credit risk fund manager is taking to get extra alpha in returns in this category. Unlike Liquid Funds, where funds are not allowed to buy low credit risk paper, no such restriction is applicable in this category.

To avoid these costs, you need to implement a systematic exit strategy before redemption begins so that you can get back what you invested and then some more. Debt funds are considered to be an ideal investment for generating regular income. For example, choosing dividend payout can be an option for regular income. Prevent Unauthorized Transactions in your demat / trading account Update your Mobile Number/ email Id with your stock broker / Depository Participant.

Short-Term Funds

CP may be issued to and held by individuals, banking companies, other corporate bodies registered or incorporated in India and unincorporated bodies, Non-Resident Indians and Foreign Institutional Investors . However, investment by FIIs would be within the limits set for their investments types of debt instruments in india by Securities and Exchange Board of India. Debt instruments can be issued by the government, municipalities, a variety of institutions, and enterprises and are extremely crucial for raising capital. The debt market is responsible for capitalizing and mobilizing cash in the economy.

Overnight Fund carry minimal credit risk and interest rate risk owing to such a short maturity period and are hence perceived to be relatively stable. This change in the bond yield due to interest rates could adversely affect your gains. Since interest rates in the economy are liable to change frequently, interest rate risk is inherently tied to all debt instruments that carry fixed rates of interest.

Investors have the option to buy and sell units at NAV which is declared on a daily basis. Both the categories are treated as Debt funds for income tax purpose as equity investment is less than 65% in both. Diversification – Investing a certain portion of your assets in debt funds shields your portfolio from the volatility of equity investments.

types of debt instruments in india

Ideally, it is a category which retail investors should avoid, if you want to invest, do check the credit risk and interest rate risk these funds take. Example, As on Mar 2021, Nippon Credit Risk fund has about 50% of investments in unrated bonds whereas IDFC Credit Risk Fund has only 5% in A or below rated papers . Short term funds are debt funds that lend to companies for a period of 1 to 3 years. These funds mostly take exposure only in quality companies that have proven record of repaying their loans on time as well as have sufficient cash flows from their business operations to justify the borrowing. But out of these three – this is the highest risk category, both in terms of interest rate and credit risk too. Banking and PSU Funds invest at least 80% of total asset in debt instruments issued by banks, PSUs, and public financial institutions.

Maturity is longer when interest rates fall and shorter when interest rates rise. Credit Opportunity Funds These funds purchase bonds in lower rated bonds to generate higher returns/yields. Suitable only for investors with a profile to take higher risk as investing down the rating spectrum adds to the risk of the portfolio. These debt mutual fund schemes invest in debt and money market instruments with Macaulay duration between 4 to 7 years . This long lending horizon makes them extremely vulnerable to changes in interest rates due to the reversal of economic or business cycle.

Things to keep in mind when investing in debt funds

If the time horizon is less than a year or just a year away, it is better to stash funds in a money-market or liquid fund. The volatility in these funds is the least as exposure to equities is non-existent. The idea is to preserve the capital and not take undue risks with the savings. Choose at least two or three debt funds for diversification and start saving through the systematic investment plan process. Ideally, keep the portfolio tilted towards debt even if you are taking a bit of risk.

Please verify with scheme information document before making any investment. You can redeem your investment as and when you need it, making them highly liquid securities. The securities can also be chosen in such a manner so that the interest payments coincide with any requirements of funds at that point of time. By using 6A-7A mechanism as available in the Equity segment is also available. The schedule of various settlement related activities like obligation download, custodial confirmation, pay-in/pay-out of funds and securities is similar to what is at present applicable in the equities segment. As per an RBI Circular, the RBI regulated entities are to settle their transactions in the Retail Debt Segment at the Exchange through a Custodian.

The Buy or sell transaction is an independent trade and is in no way connected with any other trade at the same or a later point of time. A.All G-Secs in India currently have a face value of Rs.100/- and are issued by the RBI on behalf of the Government of India. All G-Secs are normally coupon bearing and have semi-annual coupon or interest payments with a tenor of between 5 to 30 years.

It is then up to you to take the investment decision and sign the form, or channel the money to suit your financial needs. Thus, debt funds can be a good alternative to investors for achieving their financial goals if they do not intend to bear risk involved in equity investments. Overnight Fund – which invests in debt securities having a maturity of 1 day.

T-Bills in India can be issued in 3 different maturities, i.e., 91 days, 182 days, and 364 days. An important thing to note is that the money market is not made up of a single instrument. Some of the instruments are Treasury Bills, Commercial Papers and Certificates of Deposits .

  • Income Funds take a call on the interest rates and invest predominantly in debt securities with extended maturities.
  • Generating funds from friends, relatives or pawning gold might not be the best ways to arrange the money.
  • These debt instruments also allow market players to shift debt liability ownership from one person to another.
  • DBFs follow an active portfolio duration management strategy by keeping a close watch on various domestic and global macro-economic variables and interest rate outlook.

Fixed Maturity Plans Passively managed close-ended funds, where investments are held to maturity. Long-Term Income Funds Medium to long duration funds with portfolio maturity between three and 10 years. These funds benefit when interest rates fall as bond prices and interest rates are inversely correlated. Gilt Funds Medium to long duration funds with portfolio maturity between three and 20 years and negligible credit risk, The gilt portfolio of these funds does not carry credit risk, only interest rate risk. These funds benefit the most in a falling interest rate environment. Monthly income Plans Medium to long duration funds normally with exposure of less than 30% to equity.

c. Tax Deduction at Source (TDS)

As the term suggests, Fixed Maturity Plans or FMPs have a fixed locked-in period. Because of the lock-in period, the FMPs are not affected by changing interest rates. Fixed Maturity Plans are close-ended and tax-efficient and are regarded to be the best alternative to fixed deposits. Thus, those with a slightly high-risk appetite and longer investment horizons may be best suited for income debt fund investment.

types of debt instruments in india

Also, you should understand how interest rate movements, credit ratings and liquidity affect a debt fund’s performance. Theoretically, if interest rates rise, the NAV of a debt fund should fall. That’s because Bond prices move in the opposite direction as interest rates.

FD Returns

Investing in debt funds is ideal for risk-averse investors as they invest in securities that offer interest at a predefined rate and return the principal invested in full upon maturity. A fixed deposit account allows you to deposit your money for a set period of time, thereby earning you a higher rate of interest in return. Fixed deposits also give you a higher rate of interest than a savings bank account.

Unlike traditional avenues, debt funds don’t have a lock-in period and can be redeemed at any time subject to applicable exit loads. Debt funds are considered to be liquid as they can be withdrawn on any business day. Few Liquid funds also offer instant redemption facilities which allows investor to redeem upto ₹50,000 instantly per day per scheme per investor. No TDS is deducted in hand of investors on returns in debt funds, but in FDs, if your interest exceeds INR 10,000 then it is subjected to TDS by the bank. The entire income in a fixed deposit is taxable at the slab rate applicable to an individual. But in debt funds, if you hold an investment for more than 36 months you are taxed at 20 percent with an indexation benefit of the cost.

So in order to really get the most out of debt funds, it is essential that you match your investment horizon with the average maturity of the scheme. A large percentage of corporate debt in the portfolio does not bode well in the short term, as it is relatively less liquid. If the fund faces redemption pressure, it would be forced to sell these securities at a discount, lowering the NAV. Also, be wary of funds that hold a lot of unrated and unlisted debt. If you want to avoid the market fluctuations of Equity Stocks and are risk-averse, consider investing in debt-oriented mutual fund schemes. You can use debt funds as an alternative source of income to supplement your income from salary.

As on March 2021, LIC MF Government Securities Fund has MD of 2.5 years whereas on other hand, Edelweiss Government Securities Fund has MD of 8.2 which shows much higher interest rate risk than LIC’s funds. Overall, this is a very popular category (more than Rs 1.5 Lakh CrAUM as of Mar 2021)due to mostly low Credit risk and good range of Average maturity options to invest in. Overall, this is a very popular category due to mostly low Credit risk and good range of Average maturity options to invest in. Some banks may offer slightly higher rates but ask for higher amount of de posits.

These are suitable for investors who want to invest money for longer duration, for at least 3-5-year investment horizon. Tend to generate higher returns than funds returns but takes a higher risk too. When the rates go down, long duration bond funds are rewarded the most. However, in a higher interest rate scenario the long duration funds lose out badly. Dynamic bond funds are thus considered a good way of tiding over such volatility in the bond market because of their flexibility to switch to short term securities.

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