Debt funds are investment pools just like mutual funds or exchange-traded funds where core holdings are fixed income investments. A debt fund may invest in short-term or long-term bonds, securitized products, money market instruments or floating rate debt. The fee ratios on debt funds are usually low than the equity funds since the overall management costs are low. Debt mutual funds are also known as credit funds or fixed income funds. Debt funds come under fixed income asset category and they are generally used as tactical investments for low risk proportions of a portfolio which may be seeking preservation of capital or for investors who seek low risk income distributions.
There are a wide range of debt options for investors who wish for low risk income investments inside the fixed income category. Investors can also turn to passive and active investment products. Debt funds invest in fixed interest generating securities like corporate bonds, government securities, treasury bills, commercial paper and different money market instruments. Once an investor understands what is debt fund and how they function, they can easily invest in them to produce capital gains.
How does a debt fund work?
The purchase of a debt fund is similar to providing a loan to issuing entity. One of the main reasons investors opt for investing in debt funds is to earn interest income and capital appreciation. The interest that is earned on these debt securities is pre-decided along with duration after which the debt securities mature. An investor will know what they will get out of these instruments, thus they are called fixed income securities. Debt mutual funds try to optimize the returns by diversifying across different types of securities. This will allow the debt funds to earn decent returns, but there are no guaranteed returns. Although, the returns from debt funds are expected under a predictable range that makes them safer avenues for conservative investors. Debt funds invest in different securities based on the credit ratings. Fund managers generally make sure that the investors invest in high credit quality instruments. High credit ratings mean that the entity will be more likely to pay interest on debt security as well as pay back the principal amount upon maturity. Debt funds that invest in higher-rated securities are less volatile as compared to the low-rated securities.
Debt mutual funds are an ideal partner in the investors portfolio for achieving a variety of financial goals. Investors can use debt funds as a source of income for an additional way of earning income. Up and coming investors invest some portion in debt funds for purpose of liquidity. Individuals who are nearing retirement may also invest their retirement benefits in debt funds for receiving the pension.
Swarali Chavan is a finance professor. In her free time, she reads upon and studies about market investment instruments. She has spent considerable time researching ondebt mutual funds. In this article, she has provided in-depth guide on debt funds