What Are Debt Mutual Funds? Types, Benefits, & Risks Explained

Debt mutual funds are investment schemes that primarily invest in fixed-income instruments such as corporate bonds, government bonds, commercial papers, treasury bills, and other debt securities. These mutual funds invest in debt instruments mainly to earn low-risk capital appreciation and steady income. Here, we will explore more about what debt mutual funds are, along with their types, benefits, and risks.

Types of Debt Mutual Funds

Here are the types:

Types
Dynamic Bond Funds	These are actively managed funds that adjust their portfolio based on interest rate movements, with flexible maturities.
Income Funds	These funds invest in a mix of government and corporate securities to provide regular income.
Short-term and Low-Duration Funds	These funds focus on debt instruments with short- to medium-term maturities, offering returns for a 6-12 month horizon while balancing risk.
Liquid Funds	These funds invest in debt securities with a maturity of up to 91 days. They are highly liquid and suitable for the short-term parking of surplus funds.
Gilts Funds	These funds invest exclusively in government securities, which offer high safety but are sensitive to interest rate changes.
Credit Opportunities Funds	These funds invest in low-rated corporate bonds to seek higher returns, but with increased credit risk.
Fixed Maturity Plan	These are close-ended funds with a fixed maturity date, offering predictable returns if held until maturity.
Overnight funds	These funds invest in securities with a maturity of just one day, providing high liquidity and minimal risk.
Corporate Bond Funds	These funds primarily invest in high-rated corporate bonds, offering safety while balancing yield.
Ultra Short-term Debt Funds	These funds invest in instruments with a slightly longer maturity than liquid funds, making them suitable for holding periods of a few months.

Benefits of Debt Mutual Funds

Here are the key benefits:

Lower risk compared to equities: These funds carry lower market volatility, making them ideal for conservative or first-time investors.
High liquidity: Most debt mutual funds allow easy withdrawal with minimal exit load, making them a flexible investment option.
Stable and predictable returns: They provide stable returns as they invest in interest-generating instruments. While not guaranteed, these returns are more predictable than those from equities.
Diversification: Including debt funds in your portfolio helps balance risk, which is especially helpful during periods of equity market volatility.
Tax efficiency: If held for more than three years, this fund may offer reduced long-term capital gains tax compared to fixed deposits.

Risks of Debt Mutual Funds

Here are the risks: these funds are not entirely risk-free:

Credit Risk: If the issuer of a bond defaults on payment, it affects the fund's NAV. This is particularly relevant in credit risk funds.
Reinvestment Risk: The fund might not be able to reinvest matured funds at the same rate, which can affect overall returns.
Interest Rate Risk: Bond prices fall when interest rates rise. Long-duration funds are particularly sensitive to rate changes.
Liquidity Risk: Funds may face challenges in selling their securities quickly without impacting the price.

Conclusion

In conclusion, debt mutual funds are a versatile investment option for those seeking capital preservation and regular income. However, investors should be aware of the associated risks and choose funds that match their investment horizon and risk profile. We hope this guide to debt mutual funds has been helpful to you.

About the Author

Saniya

I'm a finance content writer with a BBA in FinTech, passionate about simplifying money matters for everyday Indians. I break down complex topics like investments, savings, and digital finance into easy, relatable content. My goal is to help you in a way that’s easy to understand, jargon-free, and actually useful in real life.

View All Articles by Saniya