Debt mutual funds strive to provide regular income along with scope of capital appreciation by investing in fixed interest generating instruments like treasury bills, government bonds, quasi-government bonds issues by institutions like railways, PSU banks, etc., corporate bonds, money market instruments among others.
Mutual funds that invest in highly rated instruments and that invest in short maturity instruments have less volatility and carry low risk. But those funds that invest in long term bonds with lower ratings carry higher volatility and risk.
There are various types of Debt mutual funds that invest in different instruments and maturity periods. The below are few common debt funds;
| Debt Funds | Type of Instruments/Duration | Suitability |
| Overnight Fund | Overnight securities with maturity of 1 day | Overnight Fund are Suitable for parking funds for a few days. These are safe and have negligible volatility |
| Liquid Fund | Debt and money market instruments having a maturity of up to 91 days | Liquid Fund are suitable for a couple of weeks. Better returns than savings bank accounts |
| Ultra Short Duration Fund | Debt & Money Market instruments & Macaulay duration is between 3 – 6 months | Ultra short fund returns higher than Fixed Deposits but have more volatility and risk |
| Low Duration Fund | Debt & Money Market instruments & Macaulay duration is between 6 – 12 months | Returns higher than Fixed Deposits. Have more volatility and credit quality risk. |
| Short Duration Fund | Debt & Money Market instruments & Macaulay duration is between 1 – 3 years | Low interest rate fluctuations. Suitable for short term goals |
| Medium Duration Fund | Debt & Money Market instruments & Macaulay duration is between 4 – 7 years | Suitable for conservative investors looking for debt allocation. Better tax treatment |
| Long Duration Fund | Debt & Money Market instruments & Macaulay duration is above 7 years | Higher interest rate risk and volatility. Suitable for investors how have longer investment durations |
| Dynamic Bond Fund | Investments in instruments across different durations | Suitable for investors looking to benefit from changes in interest rates and stay invested for 3 – 5 years |
| Corporate Bond Fund | Min 80% of total investments in Highly Rated Corporate Bonds | Scope for higher returns than short term funds with higher risk |
| Credit Risk Mutual Fund | Min 65% of total investments in below Highly Rated Corporate Bonds | Investments in high interest yielding low rated bonds. Risker than most other mutual funds |
The interest rates of bank fixed deposits and other small savings instruments have fallen drastically and have seriously impacted the financial goals of many individuals. Most notably is the impact on cash flows of senior citizens who depend on interest income for their daily sustenance.Preferential tax treatment – Investments that are held for more than 3 years get preferential tax treatment. The income tax department allows indexation benefits on such investments and taxed the gains at a flat tax rate of 20% post indexation irrespective of the individual’s tax slab. This effectively reducing the tax liability by a great extent.
Flexibility – These mutual funds do not have any lock-in period and allows investor to utilize their funds when any need arises. In addition, the investor can align his investments with his goal duration and maximize the returns.
No Penalty – Unlike fixed deposits, mutual funds that invest in short duration instruments have no exit load/penalty for early withdrawal. In times of need the investor does not have the additional burden of penalties.
Higher Returns – While they do offer greater returns, the returns are not guaranteed and their values are greatly linked to the interest rates and general activity in the economy.