Definition of 'Debt Funds'

Definition: Debt funds are mutual funds that invest in fixed income securities
like bonds and treasury bills. Gilt fund, monthly income plans (MIPs), short
term plans (STPs), liquid funds, and fixed maturity plans (FMPs) are some of
the investment options in debt funds. Apart from these categories, debt funds
include various funds investing in short term, medium term and long term
bonds.

Description: Debt funds are preferred by individuals who are not willing to
invest in a highly volatile equity market. A debt fund provides a steady but low
income relative to equity. It is comparatively less volatile.
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WHAT IS A MUTUAL FUND?

A mutual fund is an investment vehicle where many investors pool their money to earn
returns on their capital over a period. This corpus of funds is managed by an investment
professional known as a fund manager or portfolio manager. It is his/her job to invest the
corpus in different securities such as bonds, stocks, gold and other assets and seek to
provide potential returns. The gains (or losses) on the investment are shared collectively
by the investors in proportion to their contribution to the fund.

Why invest in mutual funds

There are many benefits of investing in mutual funds. Here are some important ones -

a. Professional expertise
Consider a situation where you purchase a new car. But the catch here is that you don’t
know how to drive. Now, you have two options:

i) you can learn how to drive

ii) you can hire a full-time driver

In the first scenario, you would have to take driving lessons, pass the driving test and
obtain a license. But if you don’t have the time for driving classes, it is better to opt for a
driver. Same is the case with investments.
Investing in financial markets requires a certain amount of skill. You need to research the
market and analyse the best options available. You need knowledge on matters such as
macro economy, sectors, company financials, from an asset class perspective. This
requires a significant amount of time and commitment from you.
 But if you don’t have the skill or the time to delve deep into the market, investing in mutual
funds can be an excellent alternative. Here, a professional fund manager takes care of
your investments and strives hard to provide reasonable returns. And just as you would
pay the driver for his chauffeuring services, you have to pay specific fees for the
professional management of your mutual fund investments.
a. Returns
One of the biggest mutual fund benefits is that you have the opportunity to earn potentially
higher returns than traditional investment options offering assured returns. This is because
the returns on mutual funds are linked to the market’s performance. So, if the market is on
a bull run and it does exceedingly well, the impact would be reflected in the value of your
fund. However, a poor performance in the market could negatively impact your
investments. Unlike traditional investments ,mutual funds do not assure capital protection.
So do your research and invest in funds that can help you meet your financial goals at the
right time in life.
a. Diversification
You may have heard the saying: Don’t put all your eggs in one basket. This is a famous
mantra to remember when you invest your money. When you invest only in a single asset,
you could risk a loss if the market crashes. However, you can avoid this problem by
investing in different asset classes and diversifying your portfolio.
If you were investing in stocks and had to diversify, you would have to select at least ten
stocks carefully from different sectors. This can be a lengthy, time-consuming process. But
when you invest in mutual funds, you achieve diversification instantly. For instance, if you
invest in a mutual fund that tracks the BSE Sensex, you would get access to as many as 30
stocks across sectors in a single fund. This could reduce your risk to a large extent.
1. Tax benefits
Mutual fund investors can claim a tax deduction of up to Rs. 1.5 lakh by investing in Equity
Linked Savings Schemes (ELSS). This tax benefit is eligible under Section 80C of the
Income Tax Act. ELSS funds come with a lock-in period of 3 years. Hence, if you invest in
ELSS funds, you can only withdraw your money after the lock-in period ends.
Another tax benefit is indexation benefit available on debt funds. In case of traditional
products, all interest earned is subject to tax. However, in case of debt mutual funds, only
the returns earned over and above the inflation rate (embedded in cost inflation index {CII})
are subject to tax. This could also help investors earn higher post tax returns.
What are different types of mutual funds?

When you enter a car showroom, you see lots of different cars. There are hatchbacks,
sedans, SUVs and maybe even sports cars. Each car in the showroom serves a different
purpose. An adventurous person may prefer a sports car while a family man with kids (and
a pet) may opt for an SUV. In the same way, there are different types of mutual funds in
India.

Each fund type aims to achieve specific goals. Here are the most popular types of mutual
funds you can find:

Types of funds based on asset

class:
a. Debt funds
Debt funds (also known as fixed income funds) invest in assets like government securities
 and corporate bonds. These funds aim to offer reasonable returns to the investor and are
considered relatively less risky. These funds are ideal if you aim for a steady income and
are averse to risk.
a. Equity funds
In contrast to debt funds, equity funds invest your money in stocks. Capital appreciation is
an important objective for these funds. But since the returns on equity funds are linked to
market movements of stocks, these funds have a higher degree of risk. They are a good
choice if you want to invest for long term goals such as retirement planning or buying a
house as the level of risk comes down over time.
1. Hybrid funds
What if you want equity as well as debt in your investment? Well, hybrid funds are the
answer. Hybrid funds invest in a mix of both equity and fixed income securities. Based on
the allocation between equity and debt (asset allocation), hybrid funds are further classified
into various sub-categories.

Types funds based on structure:

a. Open-ended mutual funds
Open-ended funds are mutual funds where an investor can invest on any business day.
These funds are bought and sold at their Net Asset Value (NAV). Open-ended funds are
highly liquid because you can redeem your units from the fund on any business day at your
convenience.
1. Close-ended mutual funds
Close-ended funds come with a pre-defined maturity period. Investors can invest in the
fund only when it is launched and can withdraw their money from the fund only at the time
of maturity. These funds are listed just like shares in the stock market. However, they are
not very liquid because trading volumes are very less.

Types of funds based on

investment objective:
Mutual funds can also be classified basis investment objectives.

a. Growth funds
The main objective of growth funds is capital appreciation. These funds put a significant
portion of the money in stocks. These funds can be relatively more risky due to high
exposure to equity and hence it is good to invest in them for the long-term. But if you are
nearing your goal, for example, you may want to avoid these funds.
a. Income funds
As the name suggests, income funds try to provide investors with a stable income. These
are debt funds that invest mostly in bonds, government securities and certificate of
deposits, etc. They are suitable for different -term goals and for investors with a lower-risk
appetite.
a. Liquid funds
Liquid funds put money in short-term money market instruments like treasury bills,
Certificate of Deposits (CDs), term deposits, commercial papers and so on. Liquid funds
help to park your surplus money for a few days to a few months or create an emergency
fund.
1. Tax saving funds
Tax saving funds offer you tax benefits under Section 80C of the Income Tax Act. When
you invest in these funds, you can claim deductions up to Rs 1.5 lakh each year. Equity
Linked Saving Scheme (ELSS) are an example of tax saving funds.
How Mutual funds and investment goals related?

Now that you know the different types of mutual funds, the question arises: ‘Which is the
best mutual fund?’

Well, there is no single or right answer to this question. This is because fund houses design
mutual funds to achieve specific financial goals. And as an investor, you need to know
which mutual funds can help you achieve your goals in the best way possible.

All your investment goals can be categorized into three broad groups:

1. Short-term goals (1-3 years): For instance, going on a family vacation in 18 months,
buying a car, etc
2. Medium-term goals (3-5 years): For instance, doing a short term course in digital
marketing in 3/4 years
3. Long-term goals (5 years or more): For instance, buying a house in the next 5-7
years
For any goals upto 12 months, it is better to invest in liquid funds since they are less volatile.
Liquid funds can be a good option to create an emergency fund. For goals between 1-3
years, you may want to invest in short term debt funds.

Hybrid funds are more suited for medium-term goals since they have the potential to
provide both capital appreciation and stability. For long-term purposes, equity funds are
suitable.

What is Systematic Investment Plans (SIP)?

One of the best features about investing in mutual funds is that you don’t need a large
amount of money to start investing. Most fund houses in the country allow investors to
begin investing with as little as Rs. 500 (some start at Rs. 100) per month through
Systematic Investment Plans (SIPs). Now, this might seem like a tiny amount to begin your
investment journey, but when you invest consistently over a considerable period, you can
achieve a substantial sum.

SIP is a method of investing in mutual funds where you invest a specific amount at fixed
intervals. This way, you can avoid timing the market and increase your wealth steadily.

Here’s an example to illustrate the SIP point:

Let’s imagine you invest Rs. 5,000 per month in an equity fund for 15 years. The fund offers
an annual return of 12%. At the end of the investment period, you would have amassed a
corpus of over Rs. 25 lakh. Now, if you continue investing the same amount for another ten
years (total 25 years), you would get a total sum of almost Rs.95 lakh! This is roughly four
times the amount in an additional ten years.

This is the power of compounding. The returns you earn in turn begin to make profits for
you. So, when you invest for a longer time frame, your gains also rise higher. But to gain
the maximum benefit of compounding, you should start investing as early as possible and
invest for as long as possible. This can give you an extended investment window to
increase your returns.