Lesson #3: What are Debt Funds?

In our previous lesson, we learned about Equity Funds, in this lesson we will learn about Debt Fund.

Debt Funds primarily invests in debentures and bonds issued by Government & Corporates. These funds are safer than equity funds, but these provide lesser returns as compared to equity in the long run.

However, the returns from debt funds are very similar to Fixed Deposits but Debt Fund offers a tax advantage over fixed deposits which we will understand in this lesson.

Investment Time Period In Debt Fund

Investment in debt funds can be done for 1 day as well as for 5 years. Because there are categories under debt fund that offers to invest our money for as low as one day.

Categories of Debt Funds

• Overnight Funds
• Liquid Funds
• Ultra-short Duration Funds
• Low Duration Fund
• Money Market Funds
• Short Duration Funds
• Medium Duration Funds
• Medium-to-Long Duration Funds
• Long-Duration Funds
• Corporate Bond Funds
• Banking & PSU Funds
• Gilt Funds
• Gilt Fund with 10-years Constant Duration
• Dynamic Funds

We will understand each category one by one in detail in our upcoming lessons.

No Commitment Required

Investments in debt fund provide you the benefit of anytime liquidity, which means you can withdraw money whenever you want from debt funds.

There is no commitment required from your end as compared to fixed deposits and recurring deposits (RD) where you need to stay invested for a pre-committed period otherwise you have to pay a fine if you withdraw earlier.

Tax Advantage

Before understanding the tax advantage of the Debt Fund, we will understand how much tax you pay on interest earned from fixed deposits.

For example, You invested Rs.10,00,000 in Fixed Deposits and you earn Rs.60,000 as yearly interest.

Now, you have to add this interest in your annual income and pay tax on that as per your tax slab.

You have to pay taxes every year, even if you hold your fixed deposits for 3 years.

Now, here’s the tax advantage that you get by investing in debt funds.

Say, you invested the same Rs.10,00,000 in debt funds here as you get Rs.60,000 as capital appreciation, you don’t need to pay taxes on this until or unless you withdraw your funds.

Here’s how income tax rules are for debt funds.

If you withdraw your money before 3 years from the date of investment, then you have to add the capital gain amount in your annual income and pay tax as per your tax slab.

But, if you withdraw your money anytime after 3 years, then you get indexation benefit on your gain, and post indexation benefit you have to pay 20% flat tax irrespective of your tax slab.

We will understand capital gain taxes in more detail in our upcoming lessons.

Conclusion

Debt funds are safer than equity funds, debt funds can be preferred for short-term investment needs, debt funds provide tax advantage over fixed deposits, these are the benefits of debt funds that we learned in this lesson.

But also remember one important thing about debt funds that not every debt fund provides the same risk-reward ratio, some debt funds may carry more risk than the reward you get – So understand carefully before investing.

Else, you can take the help of professionals while investing in Mutual Funds.

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End of Lesson #3, Click here for Full Course.

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