Types of Mutual Funds – Debt Funds

Types of Mutual Funds – Debt Funds

A Debt fund is a type of mutual fund that invests in bonds and other debt related investments. The primary goal of a debt fund is to preserve the original amount invested and to generate a steady flow of income.

A bond is purchased for a fixed period of time – during this time, the investor is paid a monthly amount, called the coupon amount. At the end of the fixed time period, the bond holder will receive the original amount invested.

2. What are the advantages of investing in debt funds?

Steady flow of income: Debt funds invest in bonds that pay a monthly coupon amount for all investments. A debt fund will usually pay back this money to its investors in the form of dividends. This produces a steady income for the investors of the debt fund.

Low management fee: Debt funds usually have a lower management fee than equity funds.

Low risk of capital Loss: Debt funds invest in bonds and the risk of losing the amount invested in a bond is quite low.

3. Are there risks involved in debt fund investing?

Yes. As with any investment, there are risks involved in investing in debt funds.

Credit Risk: For example, the bond in which the fund has invested can default – this means that the bond issuer will fail to pay back the money that was invested in the bond. However, debt investments are usually made in low risk bonds such as government issued bonds, and therefore the risk of default is quite low.

Interest Rate Risk: Interest rate changes will impact the price of the bond. Long term bonds are affected more by interest rate changes than short-term bonds.

4. What are the different types of debt funds?

Liquid Funds:

These funds are meant for investors who need to cash their investments fairly quickly, say, 3 months or less. These are low risk investments and offer returns that are slightly higher than deposit schemes.

Income Funds:

These funds will provide a steady flow of income either monthly or quarterly. Income funds are meant for investors who desire a steady flow of income.

Gilt Funds:

These funds invest in bonds issued by the Government of India. These funds are therefore very low risk in terms of credit default since the government will almost never fail to repay its debt. These funds however, carry an interest rate risk.

Floater Funds:

These funds make a majority of their investments in variable rate (or floater) bonds. These funds will therefore be affected either positively or negatively by interest rate changes.

MIPs:

These funds provide a monthly income to its investors on the form of dividends. These funds are recommended for investors who are looking to invest a large amount of money and would like a steady flow of income.