If you are an expert investor, you may have heard about debt funds. For the uninitiated, debt funds are types of mutual funds that primarily invest in fixed-interest generating securities. These include government securities, commercial papers, treasury bills, corporate bonds and more. The main aim behind investing in debt mutual funds is to earn steady interest income and capital appreciation.
This article explains the different types of debt funds and essential factors for new investors to consider before investing in them.
Types of debt funds
Typically, debt funds are categorised based on their portfolio maturity patterns or the underlying portfolio holdings.
- Liquid funds
Liquid funds invest in debt instruments that are almost risk-free and have a maturity of fewer than 91 days.
- Short-term funds
Short-term funds invest in bonds, commercial papers or certificate of deposits that have an average maturity between 1 and 3 years.
- Ultra-short-term funds
Investors who have a very short investment horizon between 1 and 12 months can opt for ultra-short-term funds. These funds invest a portion in ultra-short-term debt securities and the rest in long-term debt securities to offer steady returns.
- Dynamic bond funds
These funds are based on the fluctuating interest rate regime where the fund manager keeps changing the portfolio composition to suit the investors’ interest.
- Income funds
Income funds have an average maturity period of 5 to 6 years and primarily invest in debt securities with extended maturities.
- Gilt funds
Gilt funds are ideal for investors with a low-risk tolerance, as these funds invest in government securities alone carrying nil credit risk.
- Credit opportunities funds
These funds offer high returns by investing in lower-rated bonds with higher interest rates. However, these can be less stable as compared to other debt fund variants.
- Fixed maturity plans
Fixed maturity plans (FMPs) are closed-ended funds that keep your money locked-in for a specific period and invest in government securities or corporate bonds. Investors can only invest during the initial period offer.
Tips for novice investors before investing in mutual funds online
Here are some tips to consider before you make a mutual fund investment for maximum mutual fund benefits:
- Debt funds are prone to interest-rate risk and credit risk. It is advisable to understand all risk factors before selecting a fund for your investment portfolio.
- Debt funds tend to perform well in a falling interest rate regime. But even though they fetch a fixed interest rate, the returns may not be guaranteed.
- Debt fund managers charge an expense ratio to manage your investment portfolio. It can be a good idea to pick a fund with the lowest expense ratio to maximise the benefits of mutual funds.
If you are a beginner investor looking to invest in mutual funds, you could consider the tips as mentioned earlier before investing. Also, it can be a wise idea to determine your financial goals and investment horizon to select the right fund.