What is Debt Mutual Funds? Complete Beginner’s Guide

In India, where many people prefer to invest their money in gold or fixed deposits, mutual debt funds are frequently overlooked even though they have good potential. These funds can provide better returns than traditional options while keeping risk relatively low. If you’re looking to grow your money without diving into the stock market, debt mutual funds are worth considering.

---

What Are Debt Mutual Funds?

Debt mutual funds are investment funds that primarily put your money into fixed-income instruments like government bonds, corporate bonds, treasury bills, and other debt securities. These funds are managed by professional fund managers who aim to offer steady debt mutual fund returns with lower risk than equity. In brief, investing in a debt fund is like lending money to organizations or the government in exchange for interest.

Unlike equity funds, which invest in equities and are subject to market volatility, debt funds are thought to be more stable. They are perfect for short- to medium-term financial goals or cautious investors. Although the debt mutual fund returns might not be massive, they are predictable and carry less risk.

---

Types of Debt Mutual Funds

Debt mutual funds, based on maturity periods, are categorized into two types: short-term and long-term debt funds.

• Short-Term Debt Funds: These funds invest in instruments with shorter periods (1 to 3 years). They’re less sensitive to interest rate changes and suitable for investors with a low-risk appetite.
• Long-Term Debt Funds: These target instruments with longer periods  (more than 3 years). They may offer higher returns but come with higher interest rate risk.

---

Top Debt Mutual Funds in India

Here are the top 6 debt mutual funds in India that offer the best balance of returns, safety, and liquidity.

1. Liquid Funds

Best for: Short-term storing of extra funds (up to 91 days)
Risk Level: Low
Returns: 4% – 6%

Liquid funds invest in short-term financial market instruments like treasury bills and commercial papers. These funds provide higher returns than savings accounts while ensuring easy liquidity, making them ideal for emergency funds or storing extra funds.

Click the button below to explore more about liquid funds

2. Overnight Funds

Best for: Ultra-short-term investment (1-day maturity)
Risk Level: Minimal
Returns: 3% – 5%

Overnight funds invest in securities within just a one-day period, making them the safest debt funds. These are perfect for investors who want to earn short-term returns with zero risk of interest rate fluctuations.

3. Short Duration Funds

Best for: Investment for 1 to 3 years
Risk Level: Moderate
Returns: 6% – 8%

Short-duration funds invest in bonds with a period between 1 to 3 years. They offer better returns than fixed deposits while maintaining a low to moderate risk level, making them suitable for cautious investors.

4. Gilt Mutual Funds

Best for: Long-term investors looking for high-safety
Risk Level: Moderate to High
Returns: 6% – 9%

Gilt funds invest in government securities (G-Secs), ensuring zero credit risk. However, they are highly sensitive to interest rate changes, making them ideal for long-term investors who can handle market fluctuations.

Click the button below to explore more about Gilt funds

5. Corporate Bond Funds

Best for: Investors looking for higher returns with moderate risk
Risk Level: Moderate
Returns: 7% – 9%

Corporate bond funds invest at least 80% of their assets in high-rated corporate bonds. They provide higher returns than gilt funds with slightly more risk, making them a good option for investors seeking higher income.

6. Dynamic Bond Funds

Best for: Investors looking for flexible debt investments across different time horizons
Risk Level: Moderate to High
Returns: 6% – 9%

Dynamic bond funds do not have a fixed maturity period. Instead, fund managers adjust the portfolio based on interest rate movements. This makes them suitable for investors who want a more flexible approach to debt investments.

---

Debt Mutual Funds Taxation 

Taxation in debt mutual funds depends on how long you hold your investment. If you sell your investment within three years, the gains are classified as Short-Term Capital Gains (STCG). These are added to your income and taxed as per your applicable income tax slab, forming a key part of the tax on debt mutual funds.

If you hold your investment for more than three years, it falls under Long-Term Capital Gains (LTCG). However, as per the new rules from FY 2023-24, indexation benefits are removed for new investments, and all capital gains—short or long—are taxed according to your income slab for investments made after April 1, 2023.

For investments made before April 1, 2023, LTCG is taxed at 12.5% without indexation if held for more than 24 months and redeemed on or after July 23, 2024. Therefore, the longer you hold doesn’t necessarily reduce your tax load anymore. Hence, always evaluate the post-tax returns before investing to understand the impact of tax on debt mutual funds.

---

Advantages and Disadvantages of Debt Mutual Funds

Debt mutual funds come with both advantages and disadvantages. For Indian investors, weighing these factors is key to deciding whether they align with your financial goals and risk tolerance.

Advantages	Disadvantages
Lower risk compared to equity funds	Returns maybe lower than equity or real estate
Suitable for short to medium-term goals	Rising interest rates can lower bond values
Transparent and regulated by SEBI	Low-rated corporate bonds carry default risk if companies fail to repay on time
Can offer better post-tax returns than FDs in some cases	Returns are not guaranteed like fixed deposits
Professional management of investment	Past performance doesn’t guarantee future returns
SIP and lump sum investment options available	May carry exit load or management fees

How to Invest in Debt Mutual Funds in India

Before investing in debt mutual funds, you should consider your goals, market trends, and fund details. Select funds that align with your risk tolerance, settle for short or long-term periods based on the interest rate forecasting, and verify that the fund manager is credible and has low expenses.

For investors in India, the following is a simple guide to investing:

1. KYC Compliance: Complete your Know Your Customer (KYC) process with documents like PAN card, Aadhaar, and address proof.
2. Choose a Platform: You can invest through mutual fund apps, AMC websites, or intermediaries like banks and brokers.
3. Select the Fund: Use filters based on duration, fund rating, and risk profile.
4. Decide Investment Mode: Invest via SIP (Systematic Investment Plan) or lump sum. 
5. Track Performance: Monitor your fund’s returns periodically and rebalance if needed.

For those looking to expand their knowledge beyond debt mutual funds, our Mutual Fund Academy provides in-depth guides on various investment strategies to help you make informed financial decisions.

---

Conclusion

Debt mutual funds are a reliable investment option, offering stability, predictable returns, and lower risk. They are particularly beneficial for beginner investors or those seeking a safer alternative to equities. While they may not deliver high returns like stocks, they help balance an investment portfolio by providing steady income and capital preservation.

For Indian investors, especially beginners, debt mutual funds serve as an accessible entry point into the investment world. By understanding different fund types, taxation policies, and potential risks, investors can make informed decisions and build a balanced portfolio suited to their financial goals.

---

FAQs