Looking to invest in debt funds? Here’s how to choose the right fund

Even with such attractive qualities, choosing the right fund is important.

Debt funds are low-risk mutual funds that invest most of the money from investors into fixed income instruments. These fixed income instruments include government bonds (both state and central), corporate bonds, bonds issued by banks, treasury bills, certificates of deposit, etc.

As these are low-risk mutual funds, hence, they turn out to be one of the best options for an investor with low-risk appetite. Low-risk appetite investors often opt for debt funds as they are diversified across various securities. Debt funds also have pre-defined maturity dates, and industry experts say the returns from these funds are more or less expected. Debt funds are not much impacted by market fluctuations, unlike equity funds. Additionally, debt funds also provide better returns on investment as compared to a bank savings account and FDs. Debt funds are highly liquid, and generally seen, they can be converted into cash easily.

Also, earnings from debt funds do not attract TDS or deduction of taxes. An investor only has to pay taxes when he/she sells or withdraws funds depending on the period of the investment. When compared to the other mutual funds, debt funds have low transaction costs.

Even with such attractive qualities, choosing the right fund is important.

Due to various types of debt funds available in the market, it often becomes confusing especially for new investors to find a suitable debt fund for investing. Like any other kind of fund, a debt fund needs to be chosen depending on how well it meets with the financial goals of an investor. Experts say while selecting a fund, investors should not only access their risk appetite but also their investment horizon, and interest rate trend.

Other parameters that are essential include expense ratio, average maturity, checking the credit quality, and assets under management (AUM). AUM of a fund is the total amount invested in a particular scheme by all investors.

Experts say investors who are looking to invest for a period of 6 months to 1 year could look at short-term debt funds. This is especially ideal for investors who are looking to create an emergency fund. As compared to longer tenure products, debt funds tend to be less volatile. Investors can also consider short-term debt funds or medium duration funds depending on their investment horizon.

Having said that, even though debt funds are relatively safer than equity funds, they are not entirely risk-free like bank fixed deposits. Changes in interest rate, lack of liquidity, and credit risk are some of the risks that debt funds carry.