Debt funds are mutual funds which invest in fixed income securities such as bonds, money market instruments (treasury bills, Government bonds, non-convertible debentures) or even a combination of the two. A debt fund which invests in money market instruments is called a liquid fund. A liquid fund ensures that the principal amounts you have invested are safe. It also gives decent returns as its earnings are from interest.
Why invest in Debt Funds?
Safer than equity
Investments in debt funds are not affected by volatility in the stock market. This reduces risk in your investment.
You get lesser but more stable returns, than equity. You replace volatility with stability. Debt funds are more liquid than fixed deposits.
You can invest small amounts regularly through the SIP route. Whenever you have extra money, you can invest it in debt funds
The profit you make in the long term is taxed with an indexation benefit. You save on your taxes
Types of Debt Funds
Fixed maturity plans
Fixed maturity plans are close ended and invest in debt which matches the term of the scheme. Fixed maturity plans have tenures ranging from 3 months to 5 years. You must invest in a fixed maturity plan which matches your financial goals.
Short term Fund
They invest in debt such as bonds, commercial paper and certificates of deposit with a maturity of 3-6 months.
Taxation of Debt schemes
Short term capitals gains (gains under 3 years), are added to your taxable salary. Taxed as per income tax slab you fall under. Long term capital gains (gains over 3 years), are taxed at 20% with indexation.
Income funds invest in Government bonds, securities and even corporate debentures. They invest across a wide range of maturities. They invest in short term instruments of 1-2 years and also in long term instruments of 10-15 years.