Home>Blog>Debt Funds - The healthier alternative to FD

Debt Funds - The healthier alternative to FD

By HARSH AGARWAL

1st Jun 2022

4 mins read

Share this article:

Markets are risky! Even with all the rewards the market promises, in the long run, it is inadvisable to let your entire capital groove to the noise of Nifty. Looking for the solutions, it might seem that fixed or recurring deposits are the safest investment. However, there are caveats to this school of thought, making debt funds seem like a much more favourable option. Let's explore these funds and how do they differ from fixed deposits?

What are debt funds?

These funds invest in fixed income instruments like government bonds, debentures, treasury bills, corporate bonds etc. They are usually low-risk bonds due to their de facto disconnection from the markets.

How do these funds work?

Fund managers select the securities by balancing the ratings of the securities and the interest rates offered by them to build the investment portfolio and achieve the fund objectives. The lower-rated securities are more likely to provide a higher interest but are more likely to default. On the other hand, higher-rated securities offer a lower rate of interest but are less likely to default. The fund managers balance these very securities to achieve returns while keeping the risk-o-meter in check.

Types of debt funds

The debt funds can be classified into various types depending on the dynamics associated with the duration and their backing securities.

  • Liquid Fund - These funds invest in securities with a maturity of 91 days or less. They offer attractive returns in comparison to a savings account.
  • Money Market Funds - These funds invest in money market instruments like Certificate of Deposit, Commercial Papers, T-bills etc.
  • Corporate Bond Funds - These funds invest a minimum of 80% of the assets into highly rated corporate debt instruments.
  • Banking and PSU Funds - These funds invest a minimum of 80% of the assets into securities of banks and PSUs.
  • Gilt Funds - Like the above two, these funds invest in government-backed securities.

Several other funds exist based on the duration and credit risk.

Taxation

Debt funds can be taxed in two ways according to the asset's duration.

  • Short Term Capital Gain - The funds redeemed before three years come under this category. The capital gains made under the same are taxed as per the investor's income tax slab.
  • Long Term Capital Gain - The ones redeemed after three years come under this category and are charged at a rate of 20% after indexation benefits.

Benefits of these funds

  • Low Risk - These are the lowest risk category mutual funds available in the markets.
  • Low Expense Ratio - These funds typically have a lower expense ratio than equity and hybrid funds. This means that the investor gets a greater return on his investment.
  • Exit Load - Many subcategories to these funds have a negligible or no exit load. This means that these types of funds have greater liquidity.

Things to consider

  • Lower Returns - The funds usually have low returns compared to equity or hybrid.
  • Ratings of securities - The funds in this category offering high-interest rates often tend to invest in low rated securities. An investor must review these securities as low rated security can negatively impact the risk profile of the investment.
  • Liquidity Risk - Many of the funds in these categories tend to hold a tiny proportion of the invested asset in cash reserve, thus making it likely for the fund to be unable to meet redemption requests in heavy demand.

Debt Funds or Fixed Deposits

A question one might ask about the low rate of returns by these funds is whether one should invest in an FD or RD instead. Here's a summarized analysis for the same.

Factor FD Debt Funds
Rate of Interest Depends on the amount invested and the time frame Gives equal returns to all the investors regardless of the amount or the time frame
Liquidity The time period must be decided at the time of investment The user can withdraw the investment as per convenience.
Exit Charges A penalty that ranges from 0.5% to 1%. Much lower or sometimes equal to the former
Risk These are comparatively safer investments and only involve credit risk, i.e., many borrowers defaulting on their loans. These are riskier than the former investment.
Taxation TDS + tax according to investor's income slab. Taxed according to the period for which the assets are held.

Let's have a look at a debt fund Spenny offers:

ICICI Prudential Liquid Fund - Growth

  • AUM - 38904 Cr.
  • 5 yr annualized returns - 5.34%
  • Expense Ratio - 0.32%
  • Exit Load - 0.0070% if withdrawn after 1 day and reduces to 0.0045% if withdrawn within 6 days. No exit load after 7 days.

This was some finformation about one of the safest investment options out there. Make sure you check out Spenny to save your spare changes...

Till then. Stay Safe! Invest Safer!

FAQs

Q. What are various securities that back the debt funds?

Ans. Some of the securities are as follows

1) NCDs - Non-Convertible Debentures

2) T-bills - Treasury Bills 

3) CP - Commercial papers

4) CD - Certificate of Deposit

5) CGL - Commercial General Liability

6)SDL - State Develop Loans

These along with many other securities constitute of the portfolios of debt funds

The easiest & fastest way
to save & invest!

img
img
img

easiest and fastest way to
save and invest

Copyright 2021 Spenny Fintech Pvt. Ltd.
Made with ❤️ in India

Join our WhatsApp community to get instant updates & help

Copyright 2021 Spenny Fintech Pvt. Ltd.
Made with ❤️ in India