What are debt funds? Meaning, Features, advantages and disadvantages

(Last Updated On: April 5, 2017)

Debt Funds

Debt funds are managed by professionals that invest in high rated fixed income earning investments like State or Central government bonds, RBI bonds, various corporate deposits, money market instruments etc. It is an investment pool like mutual fund or exchange traded fund. People like you and me with an excess amount of money lying with us and wants to earn better returns than normal bank FD and do not want to take any risk are usually investing in such funds. This post digs more into What are debt funds, their features, advantages and disadvantages.

What are Debt Funds?

Simply put, Debt Fund is just another type of mutual fund. They are valued at NAV basis which keeps on changing daily

The debt funds mostly invest in fixed income earning investment while equity mutual fund invests in stock markets. This is the major difference between debt fund and equity mutual fund. Investment in debt fund is most safer and less risky.

The returns are taxed when there is a sale of debt fund unlike fixed deposits wherein interest on investment is taxed every year as per the slab. It will be long term capital gain when debt funds are sold after three years but if it is sold within three years of purchase then it will be short term capital gain

It is to be noted that debt funds are managed by the highly professional team and that is why one can rest assured that his or her money is in safe hand.

READ  Debt Funds Vs Equity Funds : The difference

Debt funds are highly liquid and tradable and one can get money back within a day time. Do keep in mind that certain debt funds charged exit load for withdrawal of amount within stipulated time frame.

Features

Let us look at some of the features of debt fund which make them unique.

  • Taxation: One peculiar feature of the debt fund is that mutual fund companies are not liable to deduct any taxes from the earning. Tax liability arises only when an investor redeems units. Moreover, he or she can avail set off gains against any other long term or short term losses.
  • Liquidity: As discussed earlier, debts fund are highly liquid and one can get redemption amount in its own bank account within a day time.
  • Previously before budget of 2014, if one held debt fund for a period of more than one year then it would be considered as long term investment. But now if that one year time period has changed to three years. So if one held debt fund for more than 36 months then it is considered as long term investment. And this is taxed at a flat rate of 20%. For short-term capital gain, it is clubbed under one’s income for that year and taxed as per slab.
  • Exit Load: Exit load is levied if investment in debt funds are sold within prescribed period generally 12 months from the date of purchase.

Advantages

  • Safer options: The most important benefit of the debt fund is that the investment is not affected by equity market risk. As the professional invest the pool of investment in highly rated fixed income instruments. Highly safer investment. The debt fund brings stability in the investment portfolio. Due to this nature of debt fund, one can expect Steady returns rather than tumultuous ride in Equity Mutual Funds. One can get regular interest income by investing in debt fund.
  • Liquidity: It is a highly liquid fund, one can withdraw it any given time and get the redemption amount in the bank account within a day. It can be treated as savings account whenever you want you can put money and whenever you want you can withdraw.
  • Better Returns: One can get decent returns than 4% in normal savings bank account and normal bank fixed deposits.
  • Indexation Benefit: One can avail the benefit of indexation and reduced tax amount on returns.
  • Taxation: Unlike FD where every year returns are taxed, in debt funds when one sale or withdraw the amount then only tax is levied.
  • Transaction Cost: The transaction cost in debt fund is low as compared to the mutual fund.
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Disadvantages

  • Debt fund mostly invests in government securities, money market instruments, corporate deposits, but there can be case when such government institution or corporate declare itself as bankrupt or defaulted in paying interest on such deposits. This makes the debt fund a bit more riskier than the traditional FD.
  • There are so many funds available in the market to chose from hence it becomes very confusing for a new investor to chose a suitable fund for him or her.
  • Nothing comes free of cost in this world. There is a cost associated with the fund like selling and marketing cost, fund manager or professionals salary etc. Hence, there is a cost associated with the fund which is charged to the investors in the form of expense ratio.
  • Individual investors have no control over day to day activities of the fund as professionals are managing the funds.

To conclude, debt funds are highly liquid and safer investment option for those who do not want to take any risk of the stock market. Those who have the spare amounts and want to earn better returns than traditional investment options.

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