The fixed deposit interest rates are declining, raising a quintessential question in investors’ minds:
“What now?” For these investors, the primary concern is whether their investments are safe. Most of the time, they do not get straight answers because many inexperienced advisors prefer to keep them confused. Operating under the harmful motto, “If you can’t convince them, confuse them,” such advisors only add to the uncertainty. That is why we, the best mutual fund advisors in Vijayawada, have brought you this article to explain everything you need to know about debt funds and the benefits and risks you should watch out for.
What are Debt Funds?
Debt funds are part of mutual funds where you invest in fixed income instruments. Examples include government securities, corporate bonds, and treasury bills. In simple terms, you lend money to a fund manager, and they use their expertise to lend it to the government or companies, generating returns for you in the form of interest.
Categories of Debt Funds
| Category | Description | Portfolio Instruments |
|---|---|---|
| Overnight Fund | Invest in securities with maturity of 1 day. | Good alternatives to savings bank due to similar liquidity, higher returns, and risk-free nature. |
| Liquid Fund | Ideal for investors with very short-term horizon. Invest in securities with maturity of up to 91 days. | Negligible interest rate risk and low credit risk. |
| Ultra Short Duration Fund | Portfolio duration of 3 to 6 months. | Low risk profile compared to longer duration funds. |
| Low Duration Fund | Suitable for investors with an investment horizon of up to 1 year. | Risk profile: Low risk. |
| Money Market Fund | Invest only in money market instruments with maturity of up to 1 year. | Low risk, high liquidity. |
| Short Duration Fund | Portfolio duration of 1 to 3 years. | Bond prices change with interest rates. |
| Medium Duration Fund | Portfolio duration of 3 to 4 years. | Longer duration means greater sensitivity to interest rate changes. |
| Medium to Long Duration Fund | Portfolio duration of 4 to 7 years. | Higher risk and yield than short duration funds. |
| Long Duration Fund | Suitable for investors with a long-term horizon. Portfolio duration greater than 7 years. | Higher risk and yields. |
| Dynamic Bond | Duration is dynamically managed. | Risk and return vary based on market conditions. |
| Corporate Bond Fund | Minimum 80% assets in AA+ and above rated corporate bonds. | Credit rating indicates financial health of companies. |
| Credit Risk Fund | Minimum 65% assets in AA+ and below rated corporate bonds. | High credit risk, low interest rate risk. |
Benefits of Debt Funds
- Better than FDs (sometimes): They can offer higher post-tax returns compared to fixed deposits.
- Liquidity: Unlike FDs, you can usually withdraw your money anytime.
- Variety: Choose from short-term funds (safer) to long-term funds (riskier).
- Tax efficiency: If held for more than 3 years, debt funds may have favorable taxation compared to FDs.
The Hidden Risks Investors Don’t See
- Credit Risk: Risk of companies defaulting, as seen in the IL&FS crisis of 2018.
- Interest Rate Risk: Bond values change with interest rate movements, especially in long-term funds.
- Liquidity Risk: Hard-to-sell bonds can delay investor redemptions if many withdraw at once.
- Concentration Risk: Heavy investment in one company or sector magnifies losses.
- Duration Risk: Longer holding periods bring higher uncertainty.
How to Choose Debt Funds Wisely
- Check credit quality (prefer AAA-rated or government securities).
- Match the fund’s horizon to your financial goals.
- Avoid chasing returns blindly.
- Look for diversification across issuers.
- Review performance every few months.
Bottom Line
Debt funds are not risk-free substitutes for fixed deposits. They can be smarter than FDs if chosen carefully
and aligned with your financial goals. But they also hide risks that most investors ignore until it’s too late.
Think of it this way:
- Fixed deposits: Like lending money to your super-safe, trustworthy uncle who always pays on time.
- Debt funds: Like lending money to a mix of friends, relatives, and businesses. Most will pay you back, some might give more returns, but one may delay or default.
If you understand the risks and choose wisely, debt funds can play an important role in your portfolio.
But never assume they are 100% safe and remember to trust your mutual fund advisor.