Also known as fixed-income funds, debt mutual funds aim to provide you with stable returns at a relatively lower risk than equity-related investments. But what are debt funds and are they suitable for you? Let us find out!

Debt mutual funds invest in debt instruments/securities like bonds (corporate and Government), money market instruments, treasury bills etc.

Simply put, when you invest in a debt instrument, you are lending money to a corporate or the Government directly. In return, they issue a security which generally has a fixed coupon (interest rate). These securities are traded in the debt market, similar to how stocks are traded in the stock market. These are the securities debt funds invest in. Each security like a bond comes with a coupon rate, face value and maturity period. For example, a company can issue bonds of face value Rs 100, at a coupon rate of 6% for a maturity period of 5 years. Till 5 years, you will get 6% returns annually, and at the end of 5 years, you will get your principal amount back.

You may wonder, how safe are debt funds? Well, debt mutual funds are not risk-free. Any investment that is entirely risk-free may not have the potential to generate higher than nominal returns- that is the risk-return trade-off. But debt mutual funds are relatively safer than equity mutual funds. If you are a risk-averse investor wanting to get better returns than the traditional saving instruments with lower volatility, then debt funds may help you. The best debt funds for you will depend on the goals that you wish to achieve with them. Click here to know more about how to link your debt funds to your life goals.

Over a period of years, both long-term and short-term investors have recognized the benefits of debt funds in their portfolios. They help you achieve a more balanced portfolio with relatively lower volatility. You can aim to benefit from debt funds on account of liquidity, relative safety, tax efficiency and returns.

Sounds interesting? Click here to know more about the benefits of debt mutual funds.

Read more about Who should invest in Debt Funds

Out of the numerous categories and a number of debt funds available in India, how do you choose the best debt funds for investment? A look at the risk-return mix of the fund can help you decide which debt funds to invest in. You can pick the right debt fund by keeping below factors in mind

To invest in debt funds

Debt funds buy the debt securities at a certain price. When you invest in a debt security, the borrower or the entity issuing the debt security fixes the interest and the maturity period. Hence, they are called fixed-income securities. Apart from this fixed interest, debt funds also earn through the change in interest rates. Interest rates and bond prices are inversely related, and the interest rate fluctuation causes the bond price to go up and down, thereby resulting in capital appreciation/depreciation. The types of bonds held by a debt mutual fund decide the extent of earning via fixed interest and capital gains/losses. This is how debt funds work.

Debt funds can manage returns by investing in securities of varying credit ratings. The credit rating mainly specifies the ability of the borrower to pay the loan back. The bonds of higher credit rating are safer than the lower credit rating, but the latter have higher coupon rates and thus, possibilities of higher returns. Here is where the fund managers play a very important role. They make well-researched decisions based on their expertise to maximize the returns from interest rate movements and credit risk calls.

Relatively stable income/returns as compared to equity, more liquidity, less volatility, and portfolio diversification are some of the many benefits of investing in debt funds. The right debt fund is a careful choice that needs to be made, keeping the whole portfolio in mind. If the right selection is made, it can help you with capital appreciation and modest returns over a period of time.