Mutual Funds Day 26: Debt Funds

In the earlier chapters, we learned about Equity funds. There is another category called Debt Funds. AMCs could choose to lend money to corporations instead of buying their shares. The returns the AMC expects when they lend money to corporates is a period interest. Just like you take a loan from a Bank, you repay the principal with an interest component as EMIs.

Debt funds are also called fixed income instruments. Instead of buying shares of a company, they buy bonds. Each bond will come with a fixed tenure and yield. The tenure could be

1. Ultra short-term like 1 to 91 days
2. Short term like 1 to 3 months
3. Short to Medium term like 6 to 12 months
4. Medium to Long term like 1 to 3 years
5. Long term like 3 to 7 years
6. Ultra Long term above 7 years

Other than the duration, debt funds could also be classified as

1. Dynamic Bond funds
2. Corporate Bond funds
3. Credit risk funds
4. Banking and PSU funds
5. Gilt funds

We will study each of these categories as a separate chapter. However, after the Union Budget 2023, the indexation benefit for long term capital gain was removed for all debt funds. Indexation benefit was the main reason why investors preferred pure debt funds over hybrid funds.

Indexation benefit reduces your tax load by subtracting the cost of inflation from the taxable income. For ease of understanding, we can say if the inflation was 5% and the returns offered by the debt funds were 8% then the taxable income would only be 8–5 = 3%.

Since the Finance Minister has removed this benefit for all debt schemes, the investors are better off selecting hybrid or equity funds.

For people who understand Fixed Deposits, it is easier to explain how debt funds work. You get the option to withdraw the interest income every month/quarter or year or you could even choose to accumulate the interest and withdraw along with capital at the end of tenure.

Debt funds can also be selected in the same way, you could choose a regular income or the capital to appreciate. Debt funds are very popular among senior investors especially those aged 60 and above as the assurance of regular income will meet most of their monthly expenses. Also, the value of the original capital will not swing unlike the equity funds and this provides a feeling of certainty.

Mutual Funds Day 27: Liquid Funds

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