The Association of Mutual Funds in India (AMFI) describes debt mutual funds as mutual fund schemes that invest in fixed-income instruments such as government and corporate bonds, money market instruments, and corporate debt securities, etc. These mutual funds are also referred to as bond funds or income funds. Such debt-oriented mutual funds are a popular investment option among several investors as they are ideal for those who do have a lower risk appetite but long for steady returns. Debt mutual funds are aptly referred to as fixed-income securities because investors can expect a certain amount of returns from such investments.
How does a debt-oriented mutual fund work?
Under a debt mutual fund scheme, money is invested in various debt securities. These securities pay a fixed rate of interest and also have a fixed maturity date. The credit rating given to the issuer is an important tool to determine and evaluate their creditworthiness. These credit ratings reflect the ability of the issuer to repay the debt. Such ratings are issued by independent rating organizations such as CRISIL, CARE, FITCH, ICRA, and Brickwork, among others, based on their research and analysis.
The debt mutual fund’s manager invests in high-rated securities to generate maximum returns possible for the investor. Investing in high-rated securities is also less volatile compared to low-rated investments. Debt mutual funds can either invest in securities that are listed or unlisted. Debt funds earn regular interest from fixed-income instruments during their tenure like deposits made with a bank but only with better returns.
Types of debt mutual funds
Based on the risk appetite and the investment horizon of an investor, debt mutual funds are bifurcated into the following types:
- Income funds
- Liquid and money market funds
- Floating rate funds (FRF)
- Short-term funds
- Dynamic bond funds
- Credit opportunities funds
- Gilt funds
- Fixed maturity funds
Benefits of investing in debt-oriented mutual funds
Individuals invest their surplus cash in debt-oriented mutual funds to build an emergency reserve. They are often termed as highly liquid mutual funds because of their ability to be redeemed in a short span.
One of the primary reasons to invest in debt-oriented funds is the low risk they expose you to.
Since debt mutual funds invest in securities that yield fixed interest, returns from a debt mutual fund are almost guaranteed. However, there is the possibility of a debt-oriented mutual fund not performing as expected due to market headwinds.
When you invest in mutual funds, you have to consider diversification. It is always recommended to diversify your portfolio. A diversified portfolio is the first step to mitigating risk effectively. Further, it is recommended to invest in a debt fund that has an appropriate allocation to different money market instruments instead of focusing on single-debt security.
Aids in achieving investment goals
Debt-oriented mutual funds are an excellent option for short-term investment objectives such as building a corpus to travel or saving for a car down payment.
With technology, it has become very easy to invest in mutual funds online and start your journey to financial freedom.