What Are Debt Funds?

Your colleague has invested in debt funds and is now encouraging you to do so too. But are you acquainted with the term ‘debt funds? Do you know all the facts associated with it?

Here, you will find everything you need to know about debt funds. And you will find answers to all your questions and doubts, to begin with.

Understand what debt funds are.

In simple terms, debt funds are mutual funds that invest in the money market and debt securities. Their purpose is to gain returns for the investors. The term debt security has varied meanings, but in this case, it refers to a financial instrument.

A financial instrument is a declaration from the issuer to the investor; to pay a certain amount of money on a specific date.

Why should you invest in debt funds?

According to the annual BMO RRSP (Registered Retirement Savings Plan) Study, 77% of Canadians have investments. If you are looking forward to investing your money in debt funds, here are three good reasons to do so:

No maturity date:

To invest money in bonds, anyone would prefer waiting till maturity. But with debt funds, you can decide on the time of maturity. As there is no set maturity date, you can keep the funds for as long as you want.

Achieve short term financial goals: 

As there is no set maturity date, you can also invest in debt funds to achieve short-term goals.

If your scope of investment is near to 1 year, you can invest for 10-12 months. This way, you will secure enough money to achieve your short-term financial goal.

Low-risk ratio: 

When investing in debt funds, the time can range from a few months to a few years. If there are fluctuations in the market, you may get the principal value of your investment. But if the price of debt funds drops after you have made the purchase, you might not receive the principal amount.

Who should invest in debt funds?

If you diversify your investment portfolio, debt funds are the best option for you. Many people also invest in these funds to get a steady source of income in retirement. It is also one of the best investment options for you if you have short-term investment goals.

What are the types of debt funds?

• Overnight funds: These funds invest in securities with a maturity period of one day. These are the funds suitable for investors looking for very short-term investments.
• Liquid funds: These funds invest in debt securities that have less than 91 days (about 3 months) to maturity. It is a good option for investors looking for temporary extra cash.
• Ultra-short duration funds: For individuals having an investment horizon of a minimum of 3 months, this is the investment option to go for. They have a higher return than the liquid funds.
• Low-duration funds: These are a moderately risky type of investment. They have the potential for investors looking at 6 months to 1 year of the investment cycle.
• Money market funds: These funds invest in the debt instruments for a marginally longer duration. They have a maturity period of up to 1 year.
• Short-duration funds: An investment duration of 1-3 years. These funds combine short- and long-term debts.
• Medium, Medium to Long, and Long Duration Funds: The investment duration for medium duration funds is between 3-4 years. For medium to long-duration funds. The investment period is 4-7 years. And the period of the long-duration fund is over 7 years. They carry a high-risk rate as they invest in various debt securities.
• Fixed Maturity Plans (FMPs): These are closed-end funds investing in debt securities with maturities that match the term of your scheme. It eliminates the interest rate risk.
• Corporate Bond Funds: These funds must invest at least 80% of the portfolio in AA+ or higher-rated corporate bonds and are suitable for investors unwilling to risk.
• Credit Risk Funds: These funds invest a minimum of 65% of total assets in corporate bonds rated AA or below and generate higher yields than corporate bond funds.
• Banking and PSU Funds: These funds invest 80% of total assets in debt instruments. Banks, PSUs, and other financial institutions issue these instruments.
• Gilt Funds: These funds make investments in various government securities with varied maturity terms. They have no risks as they are all invested in government sectors.
• Gilt Funds with 10-year constant duration: These funds invest in 80% of the government sector assets and maintain their portfolio of investment constant for 10 years.
• Floater Funds: These funds invest 65% of the assets in floating-rate bonds.
• Dynamic Funds: These dynamic funds have no restrictions on security type with no maturity profiles for investments.

What are the significant benefits of investing in debt funds?

Lower portfolio volatility:

People investing in debt funds usually do so to diversify their portfolios. These debt funds perform differently than equity funds. When the market drops, the bond prices do not rise too much. So, for this reason, you can make wise investments by combining stock funds with debt funds.

Fund management: 

When you invest in mutual funds, the responsibility of tracking events affecting issuer entities falls upon the fund managers. It is another benefit of investing in debt funds.

Liquidity: 

The debt funds are extremely easy to liquid. You can redeem them within 1-2 working days after requesting liquidity. There are no penalties for withdrawing the mutual funds.

Investment is a long journey, and it is necessary to have an unobstructed vision for your goals. Ensure stability and regulation, and you can get the most out of your investments. Going for debt funds is an excellent option for an individual investor who intends to create a diversified portfolio. But thorough research is necessary before you set up an investment strategy.

So, do you know anything about equity funds? If not, read on to find out more ‘What is an equity fund? What are its several types?’

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