ATK
New Delhi [India], January 29: Debt funds are mutual funds that invest your money in a basket of fixed-income securities like corporate bonds, government bonds, and money market instruments. These funds offer high safety and stability, as the government's creditworthiness backs them.
Let's understand some tips on choosing the right debt funds for your investment needs and their benefits.
Benefits of investing in debt funds
Capital preservation: The primary benefit of debt funds is their focus on capital preservation. By investing in low-risk instruments, debt funds shield your investment from the turbulent swings of the stock market. This makes them ideal for risk-averse investors or those nearing retirement who prioritise protecting their principal.
Regular income generation: Debt funds can be your passport to a predictable income stream. They offer regular interest or dividend payments, providing much-needed financial stability, especially for retirees or those relying on fixed income.
Diversification: By investing in debt instruments, debt funds lessen the risk associated with any single issuer. This spreads your eggs across multiple baskets, protecting you from unforeseen defaults or market fluctuations.
Liquidity: Unlike traditional bonds, debt funds offer high liquidity. You can easily buy or sell your units on the stock exchange, providing immediate access to your invested capital.
Professional management: Debt funds are expertly managed by experienced fund managers who constantly monitor market conditions. This saves you the hassle of analysing bonds and navigating the complexities of the fixed-income market.
How do debt funds work?
Here's a simplified breakdown of how debt funds operate:
Diverse portfolio: Fund managers invest in various fixed-income securities with varying maturities and credit ratings. This diversification mitigates risk and creates a stable income stream.
Professional management: Expertise comes into play, with fund managers actively managing the portfolio, buying and selling bonds based on market conditions and the fund's objectives.
Risk and returns: Your returns depend on the interest rates of the underlying securities and the credit quality of the issuers. Generally, higher-risk bonds offer higher returns, while safer, government-backed bonds provide lower but steadier returns.
Liquidity: You can conveniently buy or sell units of the fund on the stock exchange, enjoying ready access to your invested capital.
Taxation of debt funds
Investing in debt funds offers several tax benefits to investors. The taxation of debt mutual funds depends on the type of fund and the holding period.
Debt funds that invest in government securities, such as gilt funds, are generally exempt from capital gains tax (CGT). This means that any gains made from the sale of such funds are not taxed. However, investors must remember that the interest income from gilt funds is taxable. Corporate debt funds and liquid debt funds are taxed similarly to other mutual fund investments.
Investing in debt mutual funds for at least three years qualifies for long-term capital gains tax (LTCG) exemption. LTCG is applicable at a concessional rate of 20 per cent with indexation benefits, which benefits investors.
Bottom line
Debt funds offer investors a low-risk investment option with the potential to generate regular income. Understanding the different types of debt funds, their risks, and their tax implications is crucial for making informed investment decisions. By carefully evaluating your investment objectives, time horizon, and risk appetite, you can select the debt funds to achieve your financial goals.
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