Do Mutual Funds Invest Only in Stocks?

What are mutual funds?

While it is commonly assumed that mutual funds invest only in equities, it is not true. Apart from equities, mutual funds also invest in debt instruments across various categories, thus giving an investor the option to spread out their investments, and optimise their profits, rather than being invested only in equities.

What are debt mutual funds?

Debt mutual funds invest the majority of their corpus in fixed income or fixed interest generating opportunities such as money market instruments, corporate bonds, treasury bills, government securities, commercial papers etc. These funds strive to minimise risk by investing in such instruments. This also considerably reduces the chances of exponential returns in debt mutual funds as compared to their equity counterparts. It is for this reason that a debt mutual fund generates higher returns than a fixed deposit but lower than equity mutual funds.

How does a debt mutual fund work?

Debt mutual funds available on Finserv MARKETS aim to deliver stable and low risk returns unlike equity mutual fund schemes that attempt to gain capital appreciation by investing in equity stock of companies. The credit rating of a fund scheme decides the which debt instruments the fund will invest in. These ratings also indicate the likelihood of the instrument to honour its interest payments and the eventual principal payment at maturity. The higher the rating of the debt instruments chosen, the lesser is the risk associated with the debt mutual fund.

Types of debt mutual funds

There are many kinds of debt mutual funds depending on the proportion of various debt instruments they choose to invest in. Here are a few:

1. Liquid funds invest in highly liquid money-market instruments with a maturity of not more than 91 days and are less risky as they show very little fluctuation. Good for parking funds from a few days to months.

2. Ultra short-term funds are slightly riskier, with slightly higher returns. One can invest for a few months to a year in these funds that have holdings in securities with a residual maturity of not more than one year.

3. Short-term funds invest predominantly in debt securities with an average maturity of one year to 4.5 years. Go for this mutual fund if you have a low to moderate risk appetite and an investment horizon of a few years.

4. Dynamic bond funds as the name suggests, invests across debt and money-market instruments with varying maturities and have a dynamic portfolio that varies with the interest-rate view of the fund manager.

5. Credit-opportunities funds are good for those looking for medium to long term growth as these mutual funds invest predominantly in corporate bonds and debentures of varying maturities.

6. Income funds invest in corporate bonds, government bonds and money-market instruments with an average maturity of 4.5 years or more. They have a high-risk quotient since they are influenced by the prevailing interest rates, hence are suitable for those with a long term investment plan.

7. Short-term, medium-term, long-term gilt funds invest in government securities of short, medium and long-term maturities as per their declared objectives. While they may not have the default risk since the bonds are issued by the government, they come with a high degree of interest rate risk, since any change in the interest rate affects their NAV. The higher the maturity of the instrument, the higher the interest-rate risk.

8. Fixed-maturity plans or FMPs are closed-ended funds that might seem almost like a fixed deposit and may be attractive to conservative investors. They invest in debt instruments with maturities less than or equal to the maturity date of the scheme.

Who should invest in debt mutual funds?

You can invest in these funds either as a lump sum in one go or by investing small amounts of money at regular intervals for a specific time frame through a systematic investment plan or SIP. However, in case of FMPs, you cannot invest via SIPs, as the investment has to be done during the initial offer period. You should invest in debt mutual funds if:

- You cannot take the high risk of putting your money in an equity fund, but want your money to grow at a higher interest rate than that of a fixed deposit

- You prefer the possibility of small but stable returns over that of higher returns from capital appreciation in markets

- You wish to supplement your current income

Benefits of debt mutual funds

1. High liquidity: Unlike other fixed income instruments, such as fixed deposits and PPF, debt mutual funds do not come with a lock-in period. Within debt mutual funds, liquid funds provide utmost liquidity. You can withdraw your investment when you need it far more quickly as compared to other investment options.

2. Tax efficiency: Income on fixed deposits is taxed every year from the time of starting one, and the total amount earned can only be accessible at the time of maturity. Debt schemes are free from TDS and the benefit of indexation increases after three years and every passing year after that. Though long term and short term capital gains tax apply on debt schemes of mutual funds, however, they are still tax efficient as compared to others in the category.

3. Flexibility: If you want to take a higher risk, you can always transfer money from the debt fund to an equity fund through a systematic transfer plan or STP, or even invest it in another debt scheme of your choice as per your needs.

With Finserv MARKETS, you can directly invest in debt mutual funds of your choice without the need for a broker thus eliminating the need for commission. What’s more, you can easily open an account online by submitting the necessary KYC documents. Once your account is operational, you can get detailed insights into the performance of your investments and track them online anywhere, anytime.