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Are debt funds a better way to invest in fixed income than bank FDs?

Published:

Debt funds

explained: If investing in

fixed income instruments

is your financial goal, then debt funds should be considered. But, let’s first understand what are debt funds, what are the various types and what are the benefits of putting your money into them?
Debt funds are schemes that invest in fixed income instruments like corporate/government bonds, corporate debt securities, and money market instruments.

The portfolio can consist of these securities or a mix of them, depending on the scheme.
Investors have a range of options in debt funds based on their risk appetite and investment time frame. For short-term investments of 1 day to three months, overnight/liquid funds are suitable. Ultra short-term funds are ideal for 3 months to a year, while short-term funds or corporate bond funds cater to 1-3 years, states an ET report.
Long tenure Gsec funds, with a maturity exceeding 3 years, are for capitalizing on interest rate fluctuations. Those seeking predictable returns can opt for target maturity funds.

A debt scheme generates income through two primary avenues: first, via interest payments from its

bond holdings

, resulting in accrual income. Second, fluctuations in

interest rates

cause bond prices to rise or fall, leading to

capital gains

or losses. The overall return for the investor is a combination of both types of gains. The component representing capital gains or losses is also referred to as the mark-to-market (MTM) return.

Debt funds offer high liquidity, allowing redemptions before the cut-off time to reflect in the bank account the next working day. Investors can switch between schemes as needed, unlike fixed deposits that may incur penalties for premature withdrawal.
Debt funds also present the opportunity for capital appreciation when interest rates decline, a feature absent in other fixed income products.
Taxation for debt mutual funds aligns with fixed income products from April 1, 2023. Capital gains from these schemes are taxed based on the individual’s income tax slab, without long-term gains or indexation benefits.

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