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Debt Funds:
Types and Benefits of Investing in it

Debt funds have significantly grown in popularity as a source of investment returns over the last decade or so. In fact, debt funds can offer very high returns with low risk. But how do they work? Can you invest in debt funds, and if so, what kind of debt funds should you invest in? These are some of the questions that we will attempt to answer by the end of this article.

What is a Debt Fund?

Debt funds invest in different types of assets that offer higher yields than their respective investments in stocks or bonds. These include corporate and government bonds, residential housing loans and commercial real estate loans. The investment strategy of debt funds allows them to benefit from rising interest rates while also providing investors with stable returns over an extended period of time. The debt fund will enable investors to benefit from the interest payment of the underlying securities rather than relying on the volatile stock market.

Debt funds can help diversify an investor’s portfolio by investing in different types of assets. If one type of asset (e.g., corporate bonds) is performing poorly or has become too risky for investors to consider investing in anymore, then the investor may switch to another type (e.g., junk bonds).

This diversification helps reduce risk and increase potential returns for investors who choose to diversify their portfolio by investing in debt funds rather than holding all their investments in one particular asset class such as stocks or bonds alone.

How do Debt
Funds Work?

Debt funds invest in debt instruments to generate income and capital appreciation. Debt funds are similar to money market funds, which invest in high-quality government securities such as treasury bills and bonds. Money market funds invest in short-term debt securities (such as treasury bills) that mature in less than one year.

Debt funds allow investors to participate in the returns of Indian corporate bonds through an easy-to-understand fund structure without having to manage their own portfolios.

Debt funds invest primarily in government securities and corporate bonds that are issued by banks, financial institutions and insurance companies. The portfolios are diversified across all bond issuers, maturities and sectors (mixed).

The primary purpose behind investing in debt funds is to earn returns by investing in high-quality bonds issued by stable governments with good credit ratings. The higher the quality of a bond, the higher its return potential would be over time period if it remains in the portfolio for several years or even decades.

Who Should Invest in a Debt Fund?

Debt funds are an attractive option for people who want to invest in bonds but don’t have the time or inclination to do the research required to pick individual companies. These funds aim to give a reasonable average return, so they tend not to be too risky.

The primary benefit of debt funds is that they provide investors with a steady stream of income while they wait for their investments to mature.

If you’re looking for an easy way to invest in high-quality bonds at a lower cost than bank accounts or stock markets, then you should consider investing in a debt fund.

What Are the Types of Debt Funds?

1. Liquid Funds


Liquid Funds

Liquid funds invest in different types of securities like municipal bonds, corporate bonds and government securities. These types of debt instruments are considered as risk-free investments because they are backed by government authorities or well-established companies like banks or financial institutions. Liquid funds invest in these securities by getting them through primary market transactions through public sales or secondary market transactions through private placements.

The main difference between liquid funds and other debt funds is that they are not restricted to one type of debt or another. They can also invest in both fixed-income investments as well as equities. Liquid funds have lower risk than other debt funds because they tend to hold liquid assets such as short-term government securities.'

2. Short & Ultra-short-term Funds


Short & Ultra-short-term Funds

Short & Ultra-short-term debt funds are debt funds that seek to provide a return over a short period of time. These are the two most popular types of debt funds, and they have different objectives.

Short-term debt funds aim to buy low and sell high, while ultra-short-term debt funds aim to sell their investments as soon as possible in order to minimize risks and maximize profits. Short-term debt funds can be used for short-term purposes and other financial goals.

Ultra-short-term debt funds also offer higher returns than traditional short-term investment funds. While there is no guarantee that investors will make a profit from investing in ultra-short-term debt funds, they do have some advantages over traditional short-term investment funds due to their ability to generate profits more rapidly than conventional investments.

3. Money Market Funds


Money Market Funds

Money market debt funds, or money market funds as they are also known, offer investors access to short-term debt instruments. These investment products have a very low-interest rate, typically below 4 percent per annum.

The main benefit of investing in a money market fund is that it has low fees and charges. This makes them suitable for individuals who want to invest their savings and are not interested in the long-term benefits of an equity investment.

Investors can buy units through an online broker or a stockbroker, who then holds the assets on their behalf until maturity. The unit's value will increase with the economy's growth and the issuer's performance.

4. Dynamic Bond Funds


Dynamic Bond Funds

As the name suggests, Dynamic bond funds are the funds in which your fund manager keeps changing your portfolio based on the fluctuating interest rate. Dynamic bond funds can have different maturity periods because they usually invest in instruments of both longer and shorter maturity periods.

5. Corporate Bond Funds


Corporate Bond Funds

Corporate Bond Funds are one of the most popular investment options for investors who want to gain exposure to bonds. Corporate bond funds invest in bonds issued by companies with stable valuations and strong credit profiles. These funds allow you to invest in high-quality corporate bonds, providing you with better returns than stocks.

Corporate bonds, or fixed-income securities, are debt instruments that provide investors with a regular cash flow and are backed by the company issuing them. They can be highly liquid and offer a low risk of default like short-term paper. The interest rates on corporate bonds tend to be lower than those on other types of assets such as bank deposits or money market funds.

Corporate bond funds typically invest in a diversified portfolio of high-quality corporate bonds from different issuers. They will typically have an average duration of three years, which means there is enough time between each coupon payment to allow the fund manager to reinvest at least some of its proceeds into other securities in order to increase returns over time while also minimizing risk exposure through diversification.

6. Credit Risk Funds


Credit Risk Funds

Credit risk funds are designed to take on higher levels of risk than other types of funds. The goal is to maximize your return while minimizing the amount of credit you need to invest. These funds invest in debt securities of companies with a lower credit rating. Credit risk funds invest in subprime and leveraged loans, which are secured by collateral such as real estate, vehicles and other assets. These loans are more likely to default than those of companies with a better rating.

The main advantage of investing in credit risk funds is that it provides diversification benefits over standard bond funds. It also offers the opportunity to earn higher returns than fixed-income investments such as bank deposits and cash reserves.

7. Banking and PSU Fund


Banking and PSU Fund

Banks and public sector undertakings (PSUs) are the two most important types of investment funds. Banking debt funds invest primarily in medium-term time deposits with banks. Time deposit refers to money deposited for a specific period of time at a fixed interest rate that does not change after it has been deposited. This means that even if interest rates go down, your money will still earn the same interest rate until the maturity date of your deposit note.

On the other hand, PSU bond funds invest primarily in short-term notes issued by the government or by public sector enterprises (PSEs). Both types of debt funds have their benefits, but they may not be suitable for everyone.

8. GILT Funds


GILT Funds

Gilt Funds are a type of debt fund that invest in gilts or bonds issued by the Government. Gilt Funds typically invest in various gilt issues and can be used to help diversify an investment portfolio. They have the advantage of being relatively low risk and are suitable for those with a limited appetite for risk but still want to participate in the equity markets.

Gilt funds are generally very liquid funds with regular reviews and trade throughout the day on a secondary market. They can also be bought and sold directly from your broker’s website.

Gilt funds are usually considered appropriate for investors with moderate risk tolerance and various bonds available to suit your requirements.

9. Floating Rate Funds


Floating Rate Funds

Floating rate funds have a floating rate of interest. This means that the interest paid by the fund is never fixed. Instead, it changes according to market conditions and other factors. Floating rate funds are popular because they offer the flexibility to invest in a wide range of investments without any restrictions on their interest rate.

The main benefit of floating rate funds is that you can use them for short-term investment purposes. This means that you can use them for saving or investing in your retirement accounts or even as emergency funds.

10. Fixed Maturity Funds


Fixed Maturity Funds

A fixed-maturity plan is a type of debt fund that invests in a single company. Unlike a regular debt fund, the investor is promised to receive a specific amount of money at some point in the future. The fixed-maturity plan has one objective, and it is to be repaid by one entity or another.

For example, if you invest in a debt fund that has a fixed maturity date, then you will receive your principal (or interest) at the time of maturity. Therefore, you don't have to worry about losing any money if the company goes bankrupt as long as you pay back your principal at maturity.

The disadvantage of this type of investment is that it does not give you any options for investing or diversifying your portfolio. Therefore, if no dividends are coming from the company, then the value of your investment will only go down when interest rates rise or when inflation increases.

What Are the Benefits of Investing in Debt Funds?

Independent of
Equity Market

Debt funds are a type of equity fund. They invest in debt instruments, such as government bonds or corporate bonds. Debt funds can be considered to be the opposite of equity funds, which invest in stocks.

The benefit of investing in Debt Funds is that Debt Funds are Independent of the equity market.

Debt funds do not suffer from the volatility that is associated with equity markets. Debt funds have historically outperformed equity funds over time. They can continue to do so as long as they don’t have to deal with the same economic issues that affect equities, such as high inflation rates or high-interest rates.

Advantage of
Interest Rates

Debt funds are a type of equity fund. They invest in debt instruments, such as government bonds or corporate bonds. Debt funds can be considered to be the opposite of equity funds, which invest in stocks.

The benefit of investing in Debt Funds is that Debt Funds are Independent of the equity market.

Debt funds do not suffer from the volatility that is associated with equity markets. Debt funds have historically outperformed equity funds over time. They can continue to do so as long as they don’t have to deal with the same economic issues that affect equities, such as high inflation rates or high-interest rates.

Regular Income

You can expect your investment to grow steadily as long as your bond investments are made in high-quality and secure securities. The payment on the debt obligation is regularly distributed through interest payments or principal repayments. This can be used to generate regular income for you, which can be used for calculating your retirement portfolio balance, saving for college education or other expenses.

Lower Risk

Debt funds are considered to be low-risk investments because they are backed by reliable borrowers with strong credit profiles. Debt funds also have lower risk than other equities as they do not depend on the earnings of specific companies. The risk of default is minimal since these funds are guaranteed by government agencies such as the RBI. If you’re looking for a place to put your money where it will be safe, then debt funds are an excellent choice.


Diversification is one of the main benefits that investors can enjoy when they choose to invest in debt funds. The idea behind this advantage is that by investing in a wide range of assets, you will be able to reduce your overall risk. In other words, if one or two debts go wrong, it will not significantly affect your portfolio.

For example, if you have $100,000 invested in a balanced portfolio consisting of stocks and bonds, there is only one asset class (stocks) that will impact your returns. However, if you put your money into a debt fund that invests in both stocks and bonds, then all kinds of assets will be included (stocks, bonds). This means that even if one asset class goes down by 10%, you would still have enough money to cover this loss, with the other asset classes still holding strong!

Lower Risk

Debt funds are tax-efficient because you don’t have to worry about capital gains taxes when you sell your investments. Because the profit from these types of investments is taxed at lower rates, investors who hold them for a longer period of time can put more money into their retirement accounts without incurring a higher tax bill than they would have if they were just investing in regular stocks or bonds.
This can help you save more for retirement than if you were just investing in stocks or bonds directly because you won’t have to pay taxes on that income until it’s time to withdraw it from your account.
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Things to Consider Before Investing

Debt funds are a good investment if you have a cash surplus, but there are some things to consider before investing in debt funds. Many factors can affect the value of a debt instrument and its interest rate. Debt fund investors are exposed to these risks when they buy into debt funds.
The riskiest debt instruments tend to be government bonds, which often have negative real yields (the return on an investment minus inflation). However, there are a number of other risks that investors take when investing in debt funds:


Credit Risk

If the issuer of a debt instrument goes bankrupt, creditors will face losses. This risk is exceptionally high if the issuer has been issued bonds by governments, who often have less financial stability than private companies or companies in other sectors such as utilities or telecoms.



If a company fails to repay its debts, its bondholders may lose all or part of their investments. However, some issuers have limited recourse against their bondholders in the event of bankruptcy if they don’t meet certain minimum requirements, such as having sufficient cash reserves and being able to pay interest on time.


Trading Costs

Debt funds charge trading costs that can be costly if you don’t have a good exit strategy at hand when the time comes to sell your shares or redeem your fund shares. To avoid these costs, you need to implement a systematic exit strategy before redemption begins so that you can get back what you invested and then some more.
How can Freo Save’s Savings Bank Account be a Good Alternative to a Debt Fund?
A savings account by Freo Save can be a great alternative to debt funds since it brings many additional benefits. Freo Save offers you upto a 7% Interest Rate on opening a savings account which means that you can get paid while keeping your capital safe in an account. In addition to this, you can get access to the Freo Save debit card, which allows you to earn cash back and reward points on every spend. Keeping your money secured with a Freo Save account will also help you to eliminate taxes that are charged from the gains you make with Debt Funds.

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Which debt fund is the best?

There is nothing such as the best debt fund because choosing the right debt fund depends on your investment period. People who want to invest for a single day to a month can go for Liquid Funds or Overnight Funds. At the same time, people who want to go for a six-month investment can choose Ultra Short Duration Funds. In addition, Money Market funds are suitable for those who invest for six months to 1 year. Lastly, if someone is thinking of a long-term investment, you can go for Banking & PSU Bond Funds and Corporate Bond Funds.

Which debt funds are safe?

Liquid Funds and Overnight Debt Funds are considered to be the safest among all the debt funds available today. Since both of these debt funds have the lowest maturity days, the interest rate risk and credit risk that these funds can take gets significantly reduced.

Is it good to invest in debt funds?

Investing in Debt Funds is an excellent investment, especially when you want to fulfil your near-term goals and earn returns on your capital.

How do I choose a debt fund?

The first step to choosing a debt fund is determining your investment period. Once you have decided on your investment period, select a debt fund category and choose a debt fund from your selected category. Make sure you go for a fund that lends to good companies and fits your duration criteria.