Debt Mutual Funds – A better alternative for low risk Investments

Last updated: December 11th, 2017

Debt Mutual Funds types and returnsMutual funds have gained popularity over the last two decades. However, for the average investor, particularly the salaried class, investments in mutual funds have been mostly in equity mutual funds. For lower risk investments, bank FDs have remained the top choice compared to the other type of mutual funds – debt mutual funds.

Debt mutual funds function the same way as equity mutual funds, however, as the name suggests, they invest in various debt and fixed income products. These include various bonds, treasury bills, corporate deposits, government securities and money market instruments.Sounds complicated? Let us limit ourselves by understanding that they lend money to various borrowers and earn interest on the money lent. The borrowers are the Government, which is one of the largest borrowers, and various corporate bodies. These borrowers issue “receipts” for the money they have borrowed, which are called bonds, certificates, securities, etc.

The returns from debt funds are comparable with FDs and are usually slightly better. They also offer better liquidity and tax treatment. The risk is slightly greater than FDs, however, compared to equity, the risk is negligible. There are different types of debt mutual funds available depending on the investment horizon and risk ability. Let us have a look at them.

Types of Debt Mutual Funds

Liquid Funds

Liquid funds invest in highly liquid money market instruments and can have investment periods as short as a day. The investment horizon typically varies from a few days to weeks. They are excellent for investing surplus funds for short periods of time and earn a decent amount of return. The returns generally do not fluctuate much and the investment is considered safe.

Ultra Short Term Funds

Ultra short term funds invest mostly in instruments with maturity of less than a year. They are suitable for investments for a period of a few months. The returns are slightly higher than liquid funds, the risks also being marginally higher.

Short Term Funds

Short term funds invest in debt instruments which have a maturity of up to 3 years. They are a good option for an investment horizon of a few months to a year. The risks and returns are slightly higher than ultra short term funds.

Income Funds, Gilt Funds, Dynamic Bond Funds

These are medium to long term debt funds and suitable for longer investment horizons of more than a year. They mostly invest in bonds and securities with longer maturity periods and are subject to interest rate risk.

Fixed Maturity Plans

Fixed Maturity Plans are closed ended debt funds and have a fixed period of holding. They are open for investing for a few days when they are being launched and then closed until the maturity date, which might be from a few months to a few years. They are similar to bank FDs as they have a fixed holding period and are good for conservative investors.

Approximate range of returns

The following table lists the last one year returns (1 July 16 – 30 June 17) of the top performing funds for various types of debt mutual funds and the prevailing interest rate for a one year bank FD.

Debt Funds Returns for past 1 year and Bank FD rates
Please note that mutual fund returns are linked to market dynamics and past returns are not a guarantee of future performance. However, you can use them as an indicator for performance and are a good starting point for researching the best funds in the category.

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