Debt funds are mutual funds that pool money from investors to invest in debt securities that lend to various corporations and government bodies. The tenure of these instruments and the credit rating of each instrument held by a fund decide its risk level. Compared to equity funds, debt funds are often considered a safer investment option.
So, if you prefer securities offering less volatility and stable income, debt mutual funds are an excellent choice. That being said, this guide will walk you through the best debt funds for long-term benefits.
List of Top Performing Debt Mutual Funds in 2024
If you are searching for long-term investment options in India, consider tracking the performance of the following funds:
| Scheme Name | AUM (in Crores) | 5Y Returns | Expense Ratio |
| Aditya Birla Sun Life Medium Term Plan – Growth – Direct Plan | ₹1,968 | 10.49% | 0.85% |
| UTI Dynamic Bond Fund Direct – Growth | ₹560 | 8.95% | 0.66% |
| Baroda BNP Paribas Credit Risk Fund- Direct – Growth | ₹165 | 8.90% | 0.79% |
| DSP Credit Risk Fund- Direct- Growth | ₹188 | 8.76% | 0.40% |
| ICICI Prudential All Seasons Bond Fund- Direct Plan- Growth | ₹13,133 | 8.12% | 0.59% |
| ICICI Prudential Short Term Fund Direct- Growth | ₹19,923 | 7.60% | 0.45% |
| SBI Magnum Gilt Fund- Direct- Growth | ₹10,839 | 7.56% | 0.46% |
| Kotak Medium Term Fund- Direct- Growth | ₹1,845 | 7.32% | 0.67% |
| Nippon India Corporate Bond Fund- Direct- Growth | ₹5,946 | 7.22% | 0.35% |
| PGIM India Dynamic Bond Fund- Direct- Growth | ₹107 | 6.88% | 0.35% |
Disclaimer: The interest returns above reflect each fund’s performance over the past five years and is subject to change based on market fluctuations. Thus, before including any of these funds in your portfolio, please carefully consider your financial goals, investment horizon, and risk tolerance.
How Do Debt Funds Work?
Fund managers in charge of a debt fund invest in different types of debt instruments. This includes corporate bonds, government securities, treasury bills, corporate papers, certificates of deposits and money market instruments. These are typically low-risk assets offering fixed or predictable rates of returns.
Their goal is to buy debt securities at a particular price and later on sell them at a profit. This margin in between, i.e., the profit or loss, determines a debt fund’s NAV or Net Asset Value. Additionally, debt funds earn revenue in the form of interest received through bonds. Investors can realise this benefit much like the interest they get from a bank fixed deposit account.
As the fund makes more profits from its underlying assets, its NAV increases. The NAV, as discussed earlier, can vary for a debt fund based on a few factors, such as:
- The Net Asset Value has a direct relation with the underlying bonds of a debt fund. When the prevailing interest rates fall, consequently, the asset values go up, and so does the NAV of a fund. Similarly, when the interest rates decrease, the NAV goes down.
- Next, a decline in the credit ratings of existing bonds also results in a reduction of the NAV of such debt funds.
Simply put, the best debt funds for long-term goals aim to generate attractive returns through continuous transactions of debt securities. Meanwhile, their value keeps changing according to their credit ratings and fluctuating interest rates.
Key Advantages of Investing in Debt Funds
The topmost benefits of investing in debt funds are as follows:
Liquidity
A lot of debt mutual funds do not come with any lock-in period. This enables the investors to cash out their corpus at their convenience.
Stable Income
Debt funds are reputed to deliver low-risk, steady returns. Thus, they help you build a well-balanced investment portfolio where you can control the overall risk of financial losses.
High Returns
Often, debt funds outperform the returns generated from fixed deposit accounts or other singular debt securities. This happens because retail investors can readily benefit from large debt instruments by owning small units of a debt fund. Otherwise, as individuals, they could not afford to lend large amounts on their own.
Tax Efficient
You need to pay income tax on debt fund returns only after redeeming the final amount, unlike bank deposits, where taxation occurs upon interest payouts. In addition, the returns add to your taxable income, making debt funds an efficient investment vehicle if you fall under the lower tax slabs.
Should You Invest in Debt Funds?
If you identify yourself as a risk-averse investor who is satisfied with moderate yet steady returns, debt funds can be an ideal addition to your portfolio. Additionally, these funds can serve as an anchor investment for retail investors who have other, riskier equity investments.
When your goal does not involve long-term financial objectives, you can go for liquid debt funds. However, taking a long-term perspective, you can select a debt fund that has consistently delivered significant returns over the past 3-5 years and has a lock-in period.
Factors You Should Consider Before Investing in Debt Mutual Funds
Here are a few things to consider before tailoring a successful investment strategy comprising debt funds:
Investment Goals
It is important to clear out your investment objectives before you plan to generate regular income through debt funds. This is especially true because these instruments have various categories like liquid funds, long-term bond funds, mid-term credit risk funds, and more. Hence, you must pick a debt fund that complements your goals.
Risk Tolerance
Next, you should assess your risk-taking capabilities. Although debt funds pose much less risk compared to equity funds, they are still not completely risk-free. Therefore, it is highly recommended that you check your ability to withstand temporary falls in the net asset value (NAV), as this fluctuates based on credit risk and interest rate changes in the bonds held by a debt fund.
Expense Ratio
Do not forget to keep an eye on your preferred debt fund’s expense ratio. It is suggested that a mutual fund with a lower expense ratio be chosen when other similar funds are set to serve the same objectives. This is because lower expense ratios directly increase your profit share.
Once you have checked these parameters, you can purchase debt fund units via your preferred brokerage platform.
Final Thoughts:
The best debt funds for long-term investment depend on your risk appetite, investment horizon, financial objectives and expected returns. If you prefer lower risk, funds that invest in government securities and highest-rated corporate bonds are preferable. Similarly, funds with shorter maturity periods, like liquid funds, are lower in risk. On the other hand, credit-risk bond funds offer higher returns but carry higher risk compared to most debt funds.
Frequently Asked Questions
Debt funds are ideal for preserving an investor’s capital. Simultaneously, they offer better post-tax returns than most FD schemes. Therefore, for medium-term and long-term goals, debt funds can be a better option compared to other fixed-income generating instruments.
If you are a risk-averse individual who is willing to take on low risk, debt funds are a better option than equity. Additionally, managing these assets is quite easy through online stock brokerage platforms. You can sell off your positions before a debt mutual fund matures, which makes room for the desired liquidity.
Some top-rated debt funds in 2024 are DSP Credit Risk Fund Direct-Growth, UTI Dynamic Bond Fund Direct-Growth, and Baroda BNP Paribas Credit Risk Fund Direct-Growth. All these funds generated more than 8.50% returns per annum over the last five years.
