Debt funds invest in fixed-income assets such as corporate and government bonds and other debt instruments. It profits from the interest and price appreciation of the debt instruments it invests in.
Unlike Equity Funds, Debt Funds are considered low risk and are ideal for conservative investors seeking stable returns. They offer liquidity, ease of investment and diversification across various debt instruments. However, Debt Funds are subject to interest rates and credit risk.
Debt Funding (also referred to as debt financing or debt lending) is a way for a business to raise capital through means of borrowing. This funding will need to be repaid at an arranged later date, usually through regular repayments with added interest.
Yes, most debt funds allow withdrawals anytime without incurring an exit penalty. Additionally, you can set up a Systematic Withdrawal Plan (SWP) to automate monthly withdrawals from your funds.
These risks include Credit risk, Interest rate risk, Inflation risk, reinvestment risk etc. But the key risks which needs be considered before investing in Debt funds are Credit Risk and Interest Rate Risk; Credit Risk (Default Risk):
If you exit the fund before the specified tenure, then a penalty will be charged which is known as exit load. The exit load applied is 1.00% of the amount withdrawn. The tenure for equity funds is one year while for debt fund it may vary. The tenure is much shorter for short and ultra-short debt funds.
Agreeing to provide collateral to the lender puts their business assets at risk, and sometimes even their personal assets. Above all, they risk potential bankruptcy. If the business should fail, the debt must still be repaid.
DSP Gilt-G
DSP Gilt is a consistent debt fund with decent returns in the last ten years. The fund has no exit load and comes with no lock in period and a moderate risk profile.
However, investment in a dynamic bond fund for an equal tenure will offer higher returns than the bank FD. Investors also have the option of a Monthly Income Plan if they want monthly payouts akin to interest on FDs.
Approximately 18 funds offered double-digit returns during the same period. Aditya Birla SL Credit Risk Fund delivered a 12.13% return in the past year. HDFC Long Duration Debt Fund and SBI Long Duration Fund provided returns of 11.91% and 11.74%, respectively, over the last year.
No, debt funds are not tax-exempt. They are subject to taxation only at the time of sale or transfer of the capital asset.
Bond prices and interest rates have an inverse relationship; when interest rates fall, bond prices go up. This results in appreciation of the bond value that the debt funds hold which, in turn, leads to higher returns.
Novice Investor
If you have never invested in mutual funds before, investing in debt funds can be a good entry point as the risks associated are lower, and the stability of investment offered is relatively higher than equity mutual funds.
You can enhance your financial position and create long-term wealth by leveraging debt to invest in appreciating assets such as real estate, consolidate high-interest debts to improve cash flow, use high-yield savings accounts or borrow to acquire profitable businesses.
Debt Funds invest the money pooled from investors in bonds issued by banks, PSUs, PFIs (Public Financial Institutions), corporates and the Government.
Some of the major risks in these instruments/funds are: 1) Interest risk- This is also known as price risk. Whenever there is a change is the interest rates the price of a debt instrument also changes.
Two fund categories, Overnight Funds and Liquid Funds fall in this category. These are the safest funds in the debt category with negligible interest or credit risk. In these funds, safety and liquidity take the highest priority with returns being an outcome of the first two factors.
Investors start to expect that interest rate will fall more in future which further leads to an increase in current rates. This works best for existing bonds. This same kind of scenario was expected when Corona crisis hit the economy, but surprisingly debt funds gave negative returns.
During periods of financial instability, banks may increase their interest rates on loans, potentially impacting your ability to make regular payments. Some loans may also use your credit score to determine the interest rate.
Advantages of Debt Financing
Lender has no control over the business' operation. Prevents ownership dilution. Interest paid on debt is tax-deductible in most situations. Offers flexible alternatives for collateral and repayment options.
Debt financing can be difficult to obtain. However, for many companies, it provides funding at lower rates than equity financing, particularly in periods of historically low-interest rates. Another advantage to debt financing is that the interest on the debt is tax-deductible.
Do note that capital gains from the debt mutual fund bought on or before March 31, 2023, which were previously taxed as long-term capital gains at 20% with indexation, will now be taxed at 12.5% without indexation if the units were redeemed on or after July 23, 2024.
Consolidation may stretch out how long you pay on your debt. While you may pay out less each month, you may wind up paying your debt two or three years longer depending on what term you selected. However, if your debt consolidation loan has no prepayment penalty, you can pay it off early if you have the funds.
Can You Withdraw SIP Anytime? Yes, you can withdraw your SIP amount before maturity. However, withdrawing early might incur exit loads, especially if done within a year. Check the specific terms of your mutual fund for any charges.