Home Learn Demystifying Debt Funds: A Complete Guide to Intelligent Investing

Demystifying Debt Funds: A Complete Guide to Intelligent Investing

Demystifying Debt Funds: A Complete Guide to Intelligent Investing
Reading Time: 1 minutes

In the world of investments, where choices are aplenty and risks must be carefully weighed, debt funds, particularly the best performing debt mutual funds, have emerged as a compelling option for investors seeking stability and consistent returns. These funds are investment vehicles that primarily invest in fixed-income securities, such as long-term bonds, and aim to generate stable returns by earning interest income from the underlying investments.

Whether you’re a novice investor exploring what is a debt fund or a seasoned financial expert, understanding the intricacies of debt funds in India is essential to harness their potential and safeguard your financial future. In this comprehensive blog, we delve into the world of debt funds investment, shedding light on their inner workings, benefits, and considerations.

Join us as we navigate the path to financial stability, demystify the realm of examples of debt funds, and equip you with the knowledge to make informed investment decisions about which debt fund is best for your portfolio.

What are Debt Funds?

Debt funds, also known as fixed income funds, are a type of mutual fund that focuses on investments in fixed-income securities. These can include government bonds, corporate bonds, or even debentures. The main goal of these funds is to generate regular income for investors through the interest earned on these fixed-income investments.

The best thing about these funds is that they are generally considered to be less risky compared to other investment options. This is because they mainly invest in fixed-income securities that come with predetermined interest rates and maturity periods, offering a sense of stability and a higher likelihood of receiving steady returns.

However, no investment comes without risks. Debt investments still bear their own level of risk. The value of these funds can fluctuate based on factors like changes in interest rates and the creditworthiness of the issuers. Hence, it’s always a wise strategy to carefully evaluate our investment goals and risk tolerance before diving into debt mutual funds.

How Do The Top Performing Debt Funds Work?

When you invest in a debt fund, your money is pooled together with funds from other investors. The fund manager then invests this collective pool in a diversified portfolio of fixed-income securities, such as government bonds, corporate bonds, and other debt instruments.

The income generated from these investments primarily comes in the form of interest payments and periodic coupon payments. The fund manager collects these payments on behalf of the investors and distributes them proportionately among the investors based on their share in the fund.

The value of a debt fund’s units is calculated based on the net asset value (NAV) of the fund. The NAV represents the total value of the fund’s assets minus any liabilities, divided by the number of units outstanding. This metric provides an idea of how much each unit of the fund is worth, helping investors understand what is debt fund investment and how debt funds work.

Types of Debt Funds

There are various types of debt funds available to invest in, offering opportunities for how to invest in debt funds depending on your financial goals and risk tolerance. Let’s explore some of the common types:

Government Securities Funds

These investment vehicles primarily focus on government securities like treasury bills and bonds, often ranking as the best performing debt mutual funds due to their safety and stability. Backed by the government, these low-risk funds are ideal for investors seeking capital preservation with moderate growth, offering high returns at relatively lower risk.

Corporate Bond Funds

Corporate Bond Funds invest in corporate debt securities to offer income through interest from bonds with higher yields than government securities, accepting a slightly higher risk. These funds are often considered among the best debt funds for lumpsum investment due to their balance of risk and return, ideal for diversifying portfolios beyond equities and government bonds. They cater to investors with medium risk tolerance aiming to boost portfolio yield via a spectrum of corporate debts, from investment-grade to high-yield, riskier bonds.

Liquid Debt Funds

Liquid Debt Funds cater to those prioritizing safety and liquidity, aiming for returns marginally higher than savings accounts. Investing in short-duration, low-risk instruments like treasury bills, these funds provide easy access to funds with minimal risk, ideal for short-term income. Suitable for investors needing quick capital access without a lock-in period, they offer flexibility and stability for managing surplus cash or emergency funds efficiently.

Short-Term and Long-Term Debt Funds

These funds have portfolios with a mix of debt securities that have different maturity periods. Short-term debt mutual funds have shorter maturities, usually up to three years, making them a prime choice for debt fund investment with a near-term focus. On the other hand, long-term debt funds extend their maturities, ranging from three to ten years or more, appealing to investors with a longer investment horizon looking for long term bonds. Both types offer a range of options for those interested in debt investments, allowing for strategic asset allocation based on individual time frames and risk tolerance.

Ultra Short Term Debt Funds

Ultra short-term debt funds are a distinct category within the examples of debt funds, primarily investing in debt securities with a maturity of less than one year. Known for their safety and liquidity, these funds provide investors with a low-risk investment avenue, ideal for best performing debt fund seekers aiming for consistent returns. They are especially suitable for conservative investors interested in debt capital has fixed income expenses maturity, looking to mitigate interest rate risk.

Fixed Maturity Plans (FMPs)

FMPs are close-ended debt funds with a fixed maturity date, representing a unique debt fund investment strategy. They invest in debt securities that align with the fund’s maturity period, making them an attractive option for those searching for best debt funds for lumpsum investment. FMPs offer a defined investment horizon and aim to provide predictable returns based on the fixed maturity period, appealing to investors who value certainty and are looking for good debt funds that match their specific financial goals.

List of Best Debt Funds in 2024

Here is the list of best debt funds for you to invest in 2024:

Debt FundsSub CategoryAUM (In cr.)CAGR 3Y (%)Expense Ratio (%)3Y Avg Annual Rolling Return (%)
ICICI Pru Overnight FundOvernight Fund11,581.91126.430.10357.23
Bank of India Credit Risk FundCredit Risk Fund140.6142.041.1551.53
Aditya Birla SL Medium Term PlanMedium Duration Fund1,888.8613.280.8514.52
Bank of India Short Term Income FundShort Duration Fund88.1212.490.5211.98
Baroda BNP Paribas Credit Risk FundCredit Risk Fund164.8911.070.7911.56
UTI Credit Risk FundCredit Risk Fund406.0011.690.9110.70
UTI Dynamic Bond FundDynamic Bond Fund453.1910.980.719.94
Nippon India Credit Risk FundCredit Risk Fund1,
UTI Medium to Long Duration FundMedium to Long Duration Fund303.6510.141.259.30
Nippon India Strategic Debt FundMedium Duration Fund119.819.961.439.30

Please note that the above list is for educational purposes only, and is not recommendatory. Please do your own research or consult your financial advisor before investing.

Note: The list of the best debt funds to invest in India is dated 13th March 2024.

Details of the best performing debt funds in India 

  1. ICICI Pru Overnight Fund

ICICI Prudential Asset Management Company Ltd, a leading AMC in the country, manages this fund. The AMC is a joint venture between ICICI Bank and Prudential Plc, one of the UK’s largest players in the financial services sectors. The expense ratio of the fund is 0.10%.

  1. Bank of India Credit Risk Fund

This fund is managed by the Bank of India Investment Managers (formerly BOI AXA Investment Managers) is a wholly owned subsidiary of Bank of India, which was founded in 1906 as a banking services company and later nationalised in 1969. The expense ratio of the fund is 1.15%.

  1. Aditya Birla SL Medium Term Plan

The fund is managed by Aditya Birla Sun Life AMC Limited, a joint venture between the Aditya Birla Group and the Sun Life Financial Inc. of Canada. The expense ratio of the fund is 0.85%.

  1. Bank of India Short Term Income Fund

This short term income fund is managed by Bank of India Investment Managers (formerly BOI AXA Investment Managers) is a wholly owned subsidiary of Bank of India, which was founded in 1906 as a banking services company and later nationalised in 1969. The expense ratio of the fund is 0.52%.

  1. Baroda BNP Paribas Credit Risk Fund

The fund is managed by BNP Paribas Asset Management, a leading, global asset management enterprise that offers a comprehensive range of active, passive and quantitative investment solutions. The expense ratio of the fund is 0.79%.

  1. UTI Credit Risk Fund

The fund is managed by UTI AMC. The AMC commenced operations on 1st February 2003. It has been promoted by four sponsors, namely, SBI, Life Insurance Corporation of India, Bank of Baroda and Punjab National Bank, and each holds 25% of the paid-up capital of UTI AMC. The expense ratio of the fund is 0.91%.

  1. UTI Dynamic Bond Fund

This bond fund is managed by UTI AMC. The expense ratio of the fund is 0.71%.

  1. Nippon India Credit Risk Fund

The fund is managed by Nippon India Mutual Fund, one of India’s leading mutual funds, with an Average Assets Under Management (AAUM) of ₹2,79,431 cr. The expense ratio of the fund is 0.83%.

  1. UTI Medium to Long Duration Fund

UTI AMC manages the UTI Medium to Long-Duration Fund. The expense ratio of the fund is 1.25%. 

  1. Nippon India Strategic Debt Fund

Nippon India Mutual Fund manages the Nippon India Strategic Debt Fund. The expense ratio of the fund is 1.43%.

How Debt Funds are Different from Other Mutual Funds?

Debt funds, also known as fixed-income funds, differ from other mutual fund schemes primarily in terms of the underlying assets they invest in, their risk profile, and their return characteristics. Here’s a closer look at how debt funds stand apart:

FeatureDebt FundsEquity FundsHybrid Funds
Type of InvestmentsFixed-income securities like government bonds, corporate bonds, treasury bills, commercial papers.Stocks or equities of companies.A mix of equities and fixed-income securities in varying proportions.
Risk ProfileLower risk due to investment in securities offering fixed returns. Subject to interest rate, credit, and liquidity risk.Higher risk due to market volatility. Potential for higher returns makes it suitable for those with a long-term horizon.Moderate risk, falling between debt and equity funds depending on their asset allocation.
Return PotentialSteady and predictable returns, generally lower than equity funds but higher than traditional savings accounts.Potential for higher returns over the long term, suitable for investors with higher risk tolerance.Returns influenced by both the fixed income and equity components, aiming for moderate growth with reduced volatility.
Investment Objective and SuitabilityIdeal for regular income, capital preservation, and lower volatility. Suited for short to medium-term goals.Best for investors aiming for capital growth over the long term and can withstand market fluctuations.Suitable for investors seeking a mix of income and growth with moderate risk, preferring a balanced investing approach.
Tax TreatmentShort-term gains taxed as per income tax slab, long-term gains taxed at 20% with indexation (for holdings more than three years).Long-term capital gains taxed at 10% for gains exceeding ₹1 lakh without indexation, short-term gains taxed at 15%.Taxation depends on the specific allocation to equity and debt; hybrid equity-oriented funds are taxed like equity funds, and debt-oriented like debt funds.

Who Should Invest in Debt Funds? 

Debt mutual funds present an attractive investment option for individuals seeking various benefits:

  • Regular Income: A Debt fund offers a reliable source of income, making them ideal for those who rely on a steady cash flow for their expenses or supplement retirement income.
  • Liquidity: With relatively high liquidity, debt funds allow investors to easily access their invested capital by selling the funds when needed, providing financial flexibility.
  • Safety: While there is still some level of risk involved, debt mutual funds are generally considered safer than equity funds. This makes them appealing to individuals who prefer a more conservative approach to investing.

Here are some specific groups of people who can greatly benefit from investing in debt funds:

  • Retirees: For individuals looking for a steady stream of income to cover living expenses in retirement, debt funds provide a stable income source. They are an excellent tool for those who need to preserve their capital while receiving regular payouts, aligning well with the goal of supplementing retirement income.
  • Short-Term Goal Savers: Individuals saving towards imminent financial goals, like purchasing a house or a car, will find the relative safety and lower risk of debt funds advantageous. The liquidity aspect allows for quick access to funds when goals are met, making debt funds investment a prudent choice.
  • Risk-Averse Investors: For investors prioritizing capital preservation over high-risk opportunities, debt funds offer a balanced approach. They cater well to those who are cautious yet looking for some level of growth or income generation without the volatility associated with equity investments.

How to Invest in a Debt Fund in India?

Investing in a debt fund in India is streamlined to ensure accessibility for a wide range of investors. Here’s a guide to get started:

  1. Open a Demat and Trading Account: Essential for trading in the securities market, these accounts are your gateway to investing in debt mutual funds.
  2. Choose a Debt Fund: With a plethora of debt funds in India, selecting one that aligns with your investment goals and risk profile is crucial. Utilise fund factsheets and performance comparisons as tools for making an informed decision.
  3. Make a Lump Sum Investment or Start a SIP: Options for investment include a one-time lump sum investment or a Systematic Investment Plan (SIP), catering to both bulk investors and those preferring to invest gradually.
  4. Review Your Investments Regularly: Regularly assessing your investment portfolio ensures alignment with financial goals, allowing for adjustments as needed.

Advantages of Debt Fund Investment 

Investing in a debt mutual fund comes with some great advantages. Let me break them down for you:

  • Regular Income Generation: One of the key benefits of these funds is that they aim to provide you with a regular income stream. By investing in fixed-income instruments like government securities and corporate bonds, debt funds generate interest payments that can contribute to your income.
  • Lower Risk Compared to Equity Investments: If you prefer a more conservative approach to investing, debt funds can be a good option. They generally carry lower risk compared to equity investments, offering stability and potentially protecting your capital.
  • Diversification Benefits: These funds invest in a wide range of bonds issued by different entities. This diversification helps spread the risk across multiple issuers, reducing the impact of defaults on individual securities. It’s like not putting all your eggs in one basket!
  • Liquidity and Flexibility: Need quick access to your money? Debt funds offer high liquidity, allowing you to buy and sell units at the prevailing NAVs. This flexibility gives you the freedom to manage your investments according to your financial needs.
  • Potential for Capital Appreciation: While these funds primarily focus on generating income, they also have the potential for capital appreciation. Changes in interest rates can impact bond prices, creating opportunities for you to earn capital gains if you time your investments well.

Cons of Investing in Debt Funds

Debt fund investments have their own advantages, but it’s important to be aware of the potential disadvantages as well. Here are some key drawbacks to consider:

  • Limited Growth Potential: Debt mutual funds typically offer more stable returns, but they may not generate high growth compared to riskier investments like shares. If you’re seeking substantial returns, debt mutual funds may not be the best choice.
  • Debt Fund Interest Rate and Inflation Risks: These funds are affected by changes in interest rates. When rates go up, the value of existing bonds in the fund can decrease, impacting your return on debt funds. Additionally, if the fund’s returns don’t outpace inflation, your purchasing power could be eroded.
  • Credit and Default Risks: These funds invest in bonds issued by various entities. There’s always a risk that issuers may default on payments. Higher-yielding securities often carry higher credit risks, so be mindful of the credit quality of the fund’s holdings.
  • Liquidity Challenges: Some debt mutual funds, especially those with less liquid securities, may face difficulty selling assets during market downturns. This could affect your ability to exit the fund when needed.

Factors to Consider Before Investing in Debt Funds

Here are the key factors to keep in mind:

  • Risk and Return Profile: Take some time to understand the risk and return profile of the debt fund you’re considering. Every fund has its own level of risk and potential returns. So, it’s essential to figure out how comfortable you are with taking risks and choose a fund that matches your investment goals.
  • Investment Horizon: How long do you plan to stay invested? Consider your investment horizon, whether it’s short-term, medium-term, or long-term. Different debt mutual funds have varying maturities, so it’s crucial to select one that aligns with your investment timeline.
  • Expense Ratios and Fees: Don’t forget to look into the expense ratios and fees associated with the debt fund. A lower expense ratio can have a positive impact on your overall returns. Make sure to compare the costs involved and evaluate them against the fund’s performance.
  • Credit Ratings and Portfolio Quality: Check the credit ratings and portfolio quality of the debt fund. Higher-rated securities generally indicate lower credit risk. It’s wise to review the fund’s holdings and diversification strategy to understand how they manage credit risk and generate consistent returns.
  • Fund Manager Expertise: The expertise of the fund manager can play a crucial role in a fund’s performance. Take a closer look at the fund manager’s experience, investment philosophy, and track record. A skilled and experienced manager can make a real difference in delivering positive results.

Taxation and Regulatory Aspects 

When it comes to investing in debt mutual funds, understanding the taxation and regulatory aspects is crucial. Here’s what you need to know:

Taxation on Debt Mutual Fund Return 

The returns you earn from these funds are subject to taxation. If you hold the fund for less than three years, the gains will be treated as short-term capital gains and taxed according to your income tax slab rate. 

On the other hand, if you hold the fund for more than three years, the gains are considered long-term capital gains and taxed at a flat rate of 20%, with the added benefit of indexation.

Indexation Benefits

An indexation is a NIFTY tool that helps adjust the purchase price of your investment for inflation. By factoring in the cost inflation index, you can effectively reduce your taxable capital gains. This means you’ll end up paying less tax on the returns earned from your long-term debt fund investments.

Applicable Taxes and Holding Period

It’s important to keep in mind the applicable taxes based on the holding period of your debt mutual funds. If you sell your investment within three years, the gains will be added to your total income and taxed as per your income tax slab rate. 

However, if you hold the fund for more than three years, you’ll enjoy the benefit of a flat tax rate of 20%, along with indexation benefits that can help lower your tax liability.

Tips for Investing in Debt Funds

If you are planning to invest in debt mutual funds, here are some tips for you:

  • Define Your Investment Goals: Start by figuring out what you want to achieve with your investment. Are you looking for a steady income or long-term growth? Knowing your goals will help you choose the right funds that align with your financial objectives.
  • Understand Your Risk Tolerance and Timeframe: Take a moment to assess how much risk you’re comfortable with and how long you can keep your money invested. Debt funds have different risk profiles and maturity periods, so it’s crucial to choose funds that match your risk tolerance and investment timeframe.
  • Do Your Homework: Before diving into any investment, do your research. Look into different debt funds available in the market. Consider factors like historical performance, credit quality, expense ratios, and the expertise of the fund manager. This will help you make an informed decision.
  • Keep an Eye on Fund Performance: Once you’ve invested, it’s important to regularly review how your chosen debt funds are performing. Keep track of their returns, fees, and any changes in their investment strategy or management team. Staying informed will empower you to make necessary adjustments when needed.
  • Seek Professional Guidance: If you feel overwhelmed or unsure about navigating the world of debt mutual funds, don’t hesitate to seek professional advice. A financial advisor can provide valuable insights and personalized recommendations based on your unique financial situation and goals.

To Wrap It Up…

Debt mutual funds offer a compelling investment option for individuals seeking stability, regular income, and diversification in their portfolios. With a focus on fixed-income securities, these funds provide an avenue for investors to earn interest income while mitigating the higher risks. 

Additionally, the flexibility and liquidity of debt funds make them suitable for both short-term and long-term investment horizons. However, it is essential to carefully evaluate factors such as credit ratings, expense ratios, and the fund manager’s expertise before investing.


1. What are debt funds?

Debt funds are a type of mutual fund that invests in debt securities like government bonds, corporate bonds, and money market instruments. They offer lower risk compared to equity funds but still carry some risk due to fluctuations in interest rates and economic factors.

2. Why invest in a debt mutual fund?

Investors choose debt mutual funds for various reasons:

a) Income generation
b) Capital preservation
c) Portfolio diversification

3. Are debt funds tax-free?

No, they are not tax-free. The tax treatment depends on the type of debt fund and the investor’s income tax bracket. Long-term capital gains are taxed at 20%, while short-term capital gains are taxed at the investor’s marginal income tax rate.

4. Is PPF a debt fund?

No, PPF (Public Provident Fund) is not a debt fund. It is a government-backed savings scheme with guaranteed returns and tax benefits. PPF is not regulated by SEBI like mutual funds.

5. Which is better: PPF or a debt mutual fund?

PPF and debt mutual funds have different features. PPF offers guaranteed returns and tax benefits but has a 15-year lock-in period. Debt mutual funds offer flexibility and potentially higher returns, but returns are not guaranteed.

The choice depends on individual circumstances and goals. If you prioritize safety, tax benefits, and guaranteed returns, PPF may be suitable. If you seek flexibility and the potential for higher returns, a debt mutual fund may be a better option.