What are different types of Debt Mutual Funds in India
Debt mutual funds invest in debt and money market securities. Debt Mutual Funds are also subject to debt market risks and cannot give assured returns to investors. However, the risks in debt mutual funds are much lower than the risk in equity or equity oriented schemes. Debt mutual funds can help investors meet a wide variety of investment needs of 1 day to life time.
But before we know about the various types of debt mutual funds, let us learn what debt mutual funds are and how they work
We will now discuss the different types of debt mutual funds and their characteristics so that you can know which debt mutual funds are suitable for you and for what purpose.
There are three broad categories of debt funds:-
1) Money Market mutual funds 2) Short term debt mutual funds and 3) Long term debt mutual funds
Money Market Mutual Funds
Money market mutual funds invest in money market instruments like commercial papers (CPs), certificates of deposits (CDs), treasury bills etc. Money market instruments usually have very short maturity periods, less than 12 months or so. Money market mutual funds have high liquidity and low risk and they are of two types - Liquid funds and ultra-short term debt funds.
Liquid funds invest in money market instruments whose residual maturities are less than 3 months. Liquid funds have no exit load which implies that these can be redeemed at any time without paying any charges. Redemptions in liquid funds are processed within 24 hours on business days (Transaction + 1 day).
Some liquid fund schemes also offer instant redemption anytime during the day, provided the request is made through the AMC websites or AMC mobile app. Liquid funds can be used to park funds for a few days to few weeks to few months.
Often liquid funds are compared to banks savings account as they give significantly higher returns than savings bank interest while providing the same convenience.
Ultra Short Term Funds
Ultra-short term debt funds also invest in money market instruments with residual maturities ranging from 3 months to 1 year. Like liquid funds most of the ultra-short term debt funds have no exit loads, but some schemes may levy exit loads for redemptions made within a specified period (usually a few days to a week) from the date of investment.
Ultra-short term debt funds usually give little higher returns than that of liquid funds and so, if you want to invest for 3 months or more, you should invest in ultra-short term debt funds.
Ultra short term funds are also compared to savings bank account and therefore, you can check how these funds have given better returns than savings bank
Short term debt funds
Short term debt funds invest in Government bonds (also known as Gilts) and non-convertible debentures (known as corporate bonds) issued by private sector and public sector companies, which mature in 2 to 3 years period. The main investment objective of short term debt funds is income accrual and therefore the fund manager hold the securities in their portfolio till maturity to earn the interest income from them. Due to the short maturity periods of the investments, the interest rate sensitivity of short term funds is quite limited.
Investors with 2-3 years investment horizon can invest in short term debt mutual funds as they can give superior returns compared to fixed deposits and small savings schemes.
Long term debt funds
Investors who can remain invested for 3 years or more, long term debt mutual funds are good investment options as they can give both, income and capital appreciation to investors. Investors can benefit from the long term capital gains tax advantage of debt mutual funds (if they keep the investments for 3 years or more). Long term capital gains in debt funds are taxed at 20% after allowing the indexation benefits. Unlike fixed deposits there is no TDS on growth in case of Resident Individuals. The tax advantage of debt funds vis-à-vis fixed deposits make them an attractive investment options for investors who are looking for safety yet want to earn more returns than fixed deposits.
Please check this tool which shows why long term debt funds are better option than fixed deposits
Long term debt funds invest primarily in long maturity Government and Corporate bonds. These bonds can give higher yields than short term bonds, but they are subject to interest rate risk as well. If interest rate goes up, the price of long maturity bonds and the NAVs of long term debt funds will fall and if the interest rate falls, the price of long maturity bond and the NAVs of long term debt mutual fund will rise.
However, if you have a long investment horizon (at least 3 years or more) the risk minimizes as there will be periods of both rising and falling interest rates and their opposing effects will cancel out each other.
Let us check the return of top performing long term debt mutual funds
If you have good understanding of debt mutual funds and also if you are very clear about your investment horizon then you can choose the right debt fund that is best suited for your investment needs.
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