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A Debt Mutual Fund invests in financial instruments which have a specific maturity and invest in fixed income instruments. However, the returns in a debt mutual fund are not guaranteed. They mainly invest in government and corporate bonds, government securities, treasury bills, commercial papers, money market instruments, and similar fixed income instruments. Credit rating agencies provide ratings to the debt instruments, which helps an investor to understand the possibility of default. The lower the likelihood of default, the higher the credit rating. 

Debt funds are known for their fixed income generating feature and low-risk profile. The returns on these funds are often not as affected by the market fluctuations as in an equity fund. 

Who should invest?

Debt mutual funds are ideal for investors who want regular income, less volatility, and are risk-averse. Debt mutual funds are tax-efficient and earn better returns than traditional investment instruments like Fixed deposits or savings accounts. 

Types of Debt Mutual Funds in India

There are multiple types of debt funds as per duration, accrual, underlying instruments, and others. 

Liquid Fund

Liquid funds invest in Money market instruments that have a tenure of up to 91 days. As the name suggests investment is highly liquid.

Money Market Funds

These funds also invest in money market instruments where the maturity is one year. These funds are ideal for investors looking for a short-term investment that has minimum risk. Some investors use money market funds in lieu of savings account. 

Dynamic Bond Fund

Dynamic bond funds are open-ended debt schemes investing across durations. The maturity varies from 3 to 5 years. Investors with a moderate risk appetite can go for these funds. 

Corporate Bond Funds

These funds invest at least 80% of the portfolio in high-rated corporate bonds. And are suitable for risk-averse investors. 

PSU Funds and Banking Funds

These funds invest 80% of the assets into securities of PSUs and government banks and have moderate risks.

Gilt Fund

These funds invest in government bonds of varying maturities. Gilt funds have zero default risk as they invest in government securities. However, they have a high interest rate risk. 

Credit Risk Fund

These funds invest in corporate bond funds having lower ratings. Therefore usually the returns are higher compared to high-quality bond funds, but the credit risk is also higher. 

Overnight Fund

These funds invest in different debt securities having single-day maturity. These funds are usually used by large corporates for parking their temporary excess corpus mainly used for providing liquidity. 

Duration-based debt mutual funds

There are debt funds that invest in securities as per maturity only, which includes:

1. Ultra short Duration fund – 3 -6 months

2. Low Duration fund – 6 – 12 months

3. Short Duration fund – 1 year to 3 years 

4. Medium Duration fund – 3 years to 4 years

5. Medium to long Duration fund – 4 years to 7 years 

6. Long Duration fund – 7+ years

The risk, as well as the return potential, rises with the average maturity of the fund.

Taxation of Debt Mutual Funds
Any investment in a debt mutual fund for more than 36 months is considered to be long term and the capital gain is subject to a 20% taxation after indexation benefit.

If you are looking for low-risk regular income-generating investment options, you can consider debt mutual funds. 

Disclaimer: Investment in securities and other investment products is subject to market risks; read all the related terms and documents carefully before investing.