Debt Mutual Funds

Debt mutual funds focus on fixed-income instruments that deliver capital appreciation. They can be money market instruments, corporate debt securities, bonds issued by government and corporate entities.

The aim of debt mutual funds is to maximise the possibility of earning stable returns through low-risk, fixed income investments. These returns depend upon the income earned by investments assets, changes in interest rates, etc.

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What are Debt Funds?

Debt mutual funds are those money market instruments that generate fixed income and hence are also called fixed-income securities. Here are a few examples of fixed-income securities:


  • Government securities

  • Treasury bills

  • Corporate bonds

  • Commercial Papers 

  • Certificate of Deposit


These securities offer you an interest till the time of expiry of their fixed maturity period. Moreover, since debt fund returns are not directly linked to market fluctuations, they are considered to be ideal options for you if you are risk averse.

How do Debt Funds Work?

Debt mutual funds invest in listed or unlisted instruments, which earns you returns in two ways. You can generate income through the accrued interest offered on the bond holdings.

You can also make capital gains or losses when the income rates are changed. 


Note that bond prices move in the opposite direction to the changes made in interest rates. For instance, if the interest rate is reduced, the bond prices will witness a spike. 


The capital gains or losses that you make on a debt mutual fund scheme are known as market-to-market (MTM) returns or yield. MTM returns depend on the type of debut mutual funds you invest in.


Fund managers usually check the credit ratings before investing in such instruments as well as the market interest rates. This determines how volatile the scheme is and if it is better for the longer or shorter term.

Types of Debt Funds

There are varied types of debt mutual funds with different specifications that you may choose from. To decide on the best-performing debt funds you should go for, you need to know about the following categories of these funds:

  • Overnight Fund

The overnight fund, as its name suggests, invests in securities overnight, i.e., those having a maturity period of one day. Due to their short maturity period, they carry minimum risk and are hence relatively stable. 

  • Liquid Fund

Liquid Fund is a type of debt mutual fund that has a maturity period of up to 91 days. These investment options offer potentially higher returns, with some allowing an investor to avail instant redemption facility of up to ₹50,000 per day. 


These funds reduce your risk exposure and are considered a safer bet in the debt category. 

  • Ultra-Short Duration Fund

Ultra-Short Duration Funds allow you to invest in fixed-income securities and the money market for a short duration ranging between 3 to 6 months. The risk they pose is higher as compared to liquid funds, but still safe in the mutual fund universe. 

  • Low Duration Fund

A Low Duration Fund is an instrument allowing you to invest in debt securities for a duration of 6 to 12 months. They carry a higher risk as compared to liquid and ultra-short duration debt funds, but since they have no equity exposure, they are still considered safe. 

  • Money Market Fund

A Money Market Fund, as its name suggests, invests in securities from the money market. With this fund, you can invest in a debt fund for 1 year. The benefits of investing in these securities include high liquidity and potentially higher returns.

  • Short Duration Fund

Short Duration Fund invests your money in debt and money market securities that have a minimum maturity period of 12 months to 36 months. These are safer for you if you have a low risk appetite as fund managers choose companies with high ratings for this category.

  • Medium Duration Fund

Medium Duration Fund invests in instruments from debt and money market having a period of maturing of 3 to 4 years. The length of investment means that these funds are prone to volatility. 

  • Corporate Bond Fund

Corporate Bond Funds are a type of debt security that allows you to lend to a firm. The firm issues it to get the required funding, and you get to earn interest on the amount you lend. It may be the right investment option for you if you have a low risk appetite.

  • Credit Risk Fund

Credit Risk Funds are those that lend 65% of the total money to low credit-rated companies. Although these funds have a higher risk associated with them, borrower firms also pay higher interest charges to compensate. 

  • Banking and PSU Fund

These instruments invest 80% of assets in debt securities offered by Banks, Public Sector Undertakings (PSUs), Public Financial Institutions (PFIs), and Municipalities. The risk is definitely less when you invest in these schemes. 

  • Dynamic Bond Fund

Dynamic Bond Funds are those debt mutual funds having dynamic maturity duration. These funds allow the fund managers to make modifications to the portfolio based on the interest rate to earn higher debt fund returns. 


These funds are suitable for those investors who have a moderate risk appetite and can park their funds for the medium term.

  • Gilt Funds

Gilt Funds are those instruments that invest 80% of their assets in government-issued securities. Since there is minimal credit risk, these funds are generally considered risk-free and totally stable. 


However, returns offered by Gilt Funds may not be as attractive as other debt securities.

Features of Debt Funds

The following are some of the features associated with debt mutual funds:


  • Regular Interest Payments: When you invest in debt funds, you get to enjoy regular interest payouts, which act as a fixed-income component.

  • Flexible Maturity: Debt funds come in different types, with their duration ranging from one day to several years.

  • Investment Range: Debt funds offer a range of investment options when you can choose to park your funds with a corporate body, government, bank, or PSUs.  

  • Lower Risk: Unlike equity funds, debt mutual funds are generally considered to have a potentially lower risk factor. However, it also means that they provide lower returns than equity-based funds.

Benefits of Debt Funds

The following are some of the benefits that you get to enjoy by investing in debt mutual funds:


  • Flexible Maturity: Unlike other traditional investment options, debt securities come in a range of maturity periods, ranging from overnight to 3-4 years or more. Some debt funds even offer the facility of instant redemption.

  • Tax Benefits: The tax on debt securities is only deducted when you make a withdrawal or redeem the invested amount. Unlike many other investment options, there is no TDS applicable on the interest that you earn every year.

  • Lower Risk and Stability: Debt mutual funds are generally considered to be less volatile and stable in comparison to equity funds. So, you can choose to invest in these securities if you wish to provide stability along with diversification in your investment portfolio.

Taxation on Debt Funds

If you hold debt securities for less than three years, the returns earned will be taxed under your income tax slab as Short-Term Capital Gain (STCG). 


However, if you hold them for more than 3 years, the returns will be taxed at 20% as Long-Term Capital Gain (LTCG) with indexation benefit.

Risks Associated with Debt Funds

When you invest in debt mutual funds, the following are potential risks that you may have to face.


  • Credit Risk: It is the risk that the issuer may default on debt and fail to pay you the principal and the interest.

  • Interest Rate Risk: It is the risk that you may not earn the expected interest owing to the reduced interest rate on the debt mutual fund scheme.

  • Liquidity Risk: It is the risk that the issuer may not have the required sum to fulfil your redemption demand. This situation may arise if investors lose their trust in the issuer and make redemption requests simultaneously. 


In conclusion, debt funds may be the right choice for you if you wish to enjoy stability or diversify your investment portfolio. These funds offer higher returns compared to traditional investment options but lower than those with equity funds. 

To compare various top-performing debt funds and invest with ease, choose us.

Frequently Asked Questions About Mutual Funds

Do debt mutual funds have a lock-in period?

No, debt mutual funds have no lock-in period, which means you can redeem the investment amount on any working day.

Are debt funds a good investment option?

Is a debt fund safe and completely risk-free?

What is the difference between the debt fund and the equity fund?

Which debt funds are safe?


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