Debt Funds: Types, Returns & How to Start Investing

When it comes to mutual fund investing in India, people typically think of equity funds because they are more exciting, offering high risk and high reward. But what if you’re someone who focuses on stability, regular income, and less stress? This is where Debt funds come in. Debt mutual funds aim to invest in fixed-income securities like bonds and treasury bills. They don’t give overnight results, but they help to balance your portfolio, especially during a volatile market.
In this guide, we will go through everything that you need to know about debt funds, what you can expect, and how to get started.
What are Debt Funds?
Debt funds are mutual funds that pool your money and invest in fixed-income securities like government bonds, corporate bonds, and treasury bills. Rather than seeking high growth via equities, debt funds seek capital preservation along with modest returns.
And the best part? A professional fund manager handles it for you. They decide how much to allocate to each instrument, based on the objective of the fund.
Suppose you invest in a debt fund; the expert invests that amount in borrowers (companies or the government). In this manner, you receive returns via the interest payments and value appreciation in those securities.
Key Characteristics of Debt Funds
Before you actually invest, understand what makes debt funds different.
The following are the features:
- Stability: Debt funds invest in fixed-income securities, which are not as volatile as equities ( stocks).
- Lower Risk: Debt funds, though not free of risk, are relatively less risky in the sense that they invest in bonds, treasury bills, and government securities rather than market-linked equities.
- Regular Income: Debt funds, for the most part, earn income in the form of interest payments by the underlying securities.
This appeals to investors who are looking for stable returns rather than the unpredictability of share markets.
- Capital Preservation: Debt funds are designed to preserve the invested capital and generate decent returns.
They are utilised as a means to keep money securely and still expect higher returns compared to regular savings accounts.
Types of Debt Funds
Now, let’s understand the types of debt funds in India.
SEBI classifies debt mutual funds in India based on the time duration. Here’s a quick look at the main categories:
Type of Fund | What It Invests In | Maturity / Duration | Risk Level |
Overnight Fund | Overnight securities | 1 day | Very Low |
Liquid Fund | Debt & money market securities | Up to 91 days | Low |
Ultra Short Duration Fund | Debt & money market securities | 3–6 months | Low |
Low Duration Fund | Debt & money market securities | 6–12 months | Low–Moderate |
Short Duration Fund | Debt securities | 1–3 years | Moderate |
Medium Duration Fund | Debt securities | 3–4 years | Moderate |
Medium to Long Duration | Debt securities | 4–7 years | Moderate–High |
Long Duration Fund | Debt securities | More than 7 years | High (interest rate) |
Money Market Fund | Money market instruments | Up to 1 year | Low |
Corporate Bond Fund | At least 80% in high-rated (AA+ & above) corporate bonds | Varies | Low–Moderate |
Credit Risk Fund | At least 65% in lower-rated (AA & below) corporate bonds | Varies | High (credit risk) |
Dynamic Bond Fund | Mixed debt securities, actively managed across durations | Flexible (changes with interest rates) | Moderate–High |
Banking & PSU Fund | At least 80% in debt securities of banks, PSUs & financial institutions | Varies | Low–Moderate |
Gilt Fund | At least 80% in Government Securities (G-Secs) | Varies (longer-term risk) | Low (no credit risk) |
Floater Fund | At least 65% in floating-rate instruments (or converted fixed-rate securities) | Varies | Moderate |
How do Debt Funds Work?
Let’s break down, step by step, how debt funds actually work.
- Pooling Money
As you invest in a debt mutual fund, your funds are mixed with thousands of other investors’ money. This forms a huge pool that can be efficiently managed compared to investing alone.
- Investing in a Debt Instrument
The collective funds are further invested in various fixed-income instruments like government securities, corporate securities, and money market instruments. The combination of securities varies as per the debt fund type and its strategy.
- Generating Returns
Debt fund returns are received in two forms:
Interest Payments: The periodic fixed or variable interest from a debt instrument.
Capital Appreciation: The possibility of the value of the debt securities increasing if such securities are disposed of at a higher market price.
- Maturity and Liquidity
Unlike fixed deposits, most debt funds do not freeze your money for a specified period. You can withdraw your investment at any time you require, bearing applicable exit load (if any). This provides you both the advantage of maturity-linked returns and the convenience of liquidity.
Who Should Invest in Debt Funds?
The following are the kinds of investors who might find them appropriate:
1. Conservative Investors
If you want stability more rather than high returns, then debt funds are a good option. They are less risky compared to equity funds and focus on safeguarding your capital while providing better returns than a savings account.
2. Short-Term Goal Seekers
Short-term investors, who have objectives to save for a holiday, buying a car, or an emergency, can employ liquid or short-term funds. Such funds offer flexibility and consistent returns without tying your funds for extended durations.
3. Diversified Portfolio Builders
Even if you are an aggressive equity investor, including some debt funds in your portfolio helps balance risk. They guard your investments against excessive volatility.
4. Retirees and Regular Income Seekers
Debt funds can serve retirees or those in need of a regular income. Some types of debt funds give regular returns, so they are very good for maintaining day-to-day expenses.
5. Tax-Efficient Investors
For investors in higher income tax brackets, debt funds (particularly those held for over three years) may prove to be tax-efficient over fixed deposits because of the indexation benefits on long-term capital gains.
Things to Consider While Investing in Debt Funds
Though debt funds are relatively safer than equities, they are not risk-free. You should keep some risks in mind and understand how to deal with them before investing.
1. Credit Risk
Credit risk occurs when the issuer of a security or bond does not repay interest or principal in a timely manner, or when its credit rating is reduced. These occurrences can lower the value of the security and the fund that holds it.
Mitigation Strategy: To minimise credit risk, select funds with high-rated securities and a diversified portfolio. Do not select funds that invest greatly in low-rated or unrated bonds.
2. Interest Rate Risk
The price of debt securities fluctuates with interest rates in the market. When rates go up, bond prices decline and the value of the fund drops. Decreasing rates have the opposite effect.
Mitigation Strategy: Choose funds with matching maturity and duration to your investment horizon. For short-term objectives, look for liquid or short-duration funds that are less responsive to rate changes.
3. Inflation Risk
Inflation can erode the real value of your returns. Even when you are receiving constant interest, the value of that income might decrease if inflation increases more rapidly than your fund’s return.
Mitigation Strategy: Consider the real (adjusted for inflation) return of the fund. Invest in debt funds that traditionally yield more than the current inflation rate.
4. Reinvestment Risk
This risk arises when the interest or principal you receive needs to be reinvested, but at a lower rate than before. This can diminish your total returns over time.
Mitigation Strategy: Invest in funds with a history of stable performance. Spreading across various types of debt funds can also limit the dependence on reinvestment at unfavourable rates.
How to Invest in Debt Funds in India
You can start investing with Shoonya’s transparent pricing policy, a free Demat trading account, and access to advanced trading tools.
Here’s how you can start investing with Shoonya:
Step 1: Get the Shoonya App
Start by downloading the Shoonya app or simply log in to Shoonya.com via web.
- Android: Download the new Shoonya Android app
- iOS: Get the new Shoonya iOS app
Step 2: Open a Free Demat & Trading Account
Register on the Shoonya platform using your mobile number and complete the KYC process.
Know the complete process to open a demat account on Shoonya!
Step 3: Log in to the Shoonya App or Web Platform
Once your account is active, log on to the Shoonya mobile app (Android or iOS) or Shoonya.com.
Step 4: Visit the Mutual Funds Section
From the dashboard, go to the Mutual Funds tab.
Here, you can choose Debt Funds from Collections. You will see available schemes by top fund houses.
Step 5: Compare and Choose a Fund
Use Shoonya’s tools to verify fund details such as risk level, past performance, expense ratio, and portfolio holdings. Compare various funds to identify one that suits your goals and time horizon.
Step 6: Invest via SIP or Lumpsum
Select the way you wish to invest:
- SIP (Systematic Investment Plan): Invest a specific amount month after month for systematic wealth creation.
- One Time: Invest an amount in a lump sum (one transaction) if you have extra cash.
Step 7: Monitor and Manage Investments
Shoonya allows you to track your investments in real-time. You can observe fund performance, monitor returns, and redeem units at any time.
Conclusion
Debt funds are a smart choice if you want stable returns with lower risk compared to equities. They ensure that your capital remains safe while providing better growth than a fixed deposit or savings account.
Whether your goal is short-term savings, steady income, or adding balance to your portfolio, debt funds can be a useful part of your investment plan.
Start investing in debt funds with Shoonya today. Open your free Demat account now!
What is Debt Funds | FAQs
A debt fund is a type of mutual fund that invests mainly in fixed-income instruments like government bonds, corporate bonds, and treasury bills.
Return on debt funds usually varies between 4% to 8% a year, depending on the fund type, market interest rates, and the portfolio’s credit quality.
Debt funds are safer than equities since they invest in fixed-income securities, but are not riskless. They are affected by risks such as changes in interest rates and issuers’ creditworthiness.
Fixed deposits (FDs) return fixed amounts, whereas debt funds have the potential to give a higher return with enhanced liquidity and tax advantages when held for the long term. FDs, however, are risk-free, whereas debt funds involve some degree of market risk.
You can invest in debt funds on platforms such as Shoonya, where you can search for the best mutual fund schemes, compare their performance, and invest using SIP or lump sum.
Source: AMFI
Disclaimer: Investments in the securities market are subject to market risks; read all the related documents carefully before investing.