Debt Funds Guide: Types, Benefits, Risks & Investment Tips

If you are looking for safer ways to grow your money via ULIPs, a smart way to do it is by opting for debt funds. Debt funds invest in fixed-income instruments like bonds and government securities, offering steady returns with lower risk compared to equity funds. 

In this guide, you’ll learn what debt funds are, the different types of debt funds, their benefits, possible risks, and useful tips to invest wisely. Whether you’re a beginner or an experienced investor, this simple guide will help you understand how debt funds can help you with your life goals. 

What Are Debt Funds? 

Debt funds invest your money in fixed-income instruments such as: 

• Government Bonds: These are long-term loans taken by the Government of India. When you invest in a government bond, you're lending money to the government, and they promise to pay you interest and return your money after a few years. They are safe, low-risk, long-term investment. 
• Corporate Bonds: These are loans issued by companies to raise money for business needs. You get regular interest, and your money is repaid at maturity. They are slightly higher risk than government bonds, but often better returns. 
• Money Market Instruments: A general term for short-term financial products all typically under one year in duration. They are:    
• Treasury Bills (T-Bills): Short-term loans issued by the government (91, 182, or 364 days). You buy them at a discount and get the full amount at maturity. Very safe, short-term, and used in liquid funds.  
• Commercial Papers (CPs): Short-term debt issued by large companies to meet quick funding needs (usually for a few weeks to a year). They offer better returns but carry more risk than T-Bills. Used in some short-term and liquid debt funds.     
• Certificate of deposit: A Certificate of Deposit is a short-term deposit instrument issued by banks and financial institutions. It is similar to a fixed deposit but is tradable in the market. CDs typically offer higher interest rates than savings accounts and come with maturities ranging from 7 days to 1 year (for banks) and up to 3 years (for financial institutions). They are commonly used in money market and liquid funds for safe, short-term returns.  

They are low-risk, short-term products, used by funds for liquidity and stability.    

Debt Funds vs. Equity Funds: 

Debt funds aim to generate regular income and stable returns, while keeping your money safe. They do not invest in stocks. Lets see how different they are from equity funds:  

• Debt funds are suitable if you want lower risk and steady income. 
• Equity funds invest in company shares and can offer higher returns, but also come with higher risk. 

Debt funds are ideal if you want to grow your money steadily over a short to medium term, or if you want to balance the risk in your investment portfolio. 

Types of Debt Funds 

Here is a quick overview of the different types of debt funds, so you can choose the right one for your needs: 

•   Liquid Funds: Invest in very short-term securities (up to 91 days). Good for parking idle cash or building an emergency fund.   
• Short-Term Debt Funds: Invest in bonds with a maturity of 1 to 3 years. Great for those who want better returns than savings accounts or fixed deposits, with minimal risk.   
• Medium-Term Debt Funds: Invest in bonds with a maturity of 3 to 5 years. Suitable for medium-term goals like buying a car or saving for a family vacation.   
• Long-Term Debt Funds: Invest in bonds with a maturity of 5 years or more. Good for long-term wealth building with some risk of price changes due to changing interest rates.   
• Gilt Funds: Invest only in government bonds. Very safe because they are backed by the government, but returns can change based on interest rates.   
• Credit Risk Funds: Invest in corporate bonds that offer higher returns but carry some risk that the company may delay or miss payments. Suitable for those comfortable with a little more risk.   
• Dynamic Bond Funds: Actively managed funds that adjust where they invest depending on interest rate trends. Useful if you want your investment to respond flexibly to market changes. 

Benefits of Investing in Debt Funds 

• Steady and Safer Returns: Debt funds offer more stable and predictable returns compared to equity funds. A good choice if you want your money to grow with less ups and downs.   
• Regular Income: Many debt funds provide regular income through interest payouts or dividends, making them useful for retirees or anyone seeking extra income.   
• Diversification: Debt funds help balance your portfolio, reducing risk if you already invest in equities or other higher-risk options.   
• Liquidity: Debt funds offer easy access to your money when you need it. Unlike fixed deposits, you can usually withdraw without big penalties.   
• Tax Efficiency%: Debt funds can be more tax-efficient than fixed deposits, especially if you hold them for over three years. You can use tax benefits to reduce the taxes on your gains. 

Risks Associated with Debt Funds 

While debt funds are generally safer than equity funds, they do have some risks: 

• Risk from Changing Interest Rates: If interest rates rise, the value of bonds in the fund can fall temporarily, affecting returns. If rates fall, bond values go up, helping returns.   
• Risk of Companies Not Paying Back: Some corporate bonds in the fund may carry a small chance that the company delays or defaults on payments. This can impact the fund’s value.   
• Risk of Not Getting Money Out Quickly: In rare market situations, the fund may take a little more time to sell investments and give your money back. This is called a liquidity risk.   
• Inflation Risk: If inflation is higher than your returns, your real purchasing power may go down.   
• Market Risk in Dynamic Bond Funds: Actively managed funds may perform differently depending on how interest rates and markets move. 

Tips for Investing in Debt Funds   

• Match Fund Choice with Your Goal: Choose your debt fund based on how long you plan to invest: 
  • Liquid/short-term funds for 1 to 3 years 
  • Medium/long-term funds for 3 to 5+ years 

• Check Fund Performance and Credit Quality: Review the fund’s past returns and the quality of the bonds it holds. Stick with funds that mainly invest in high-quality bonds if you prefer safety. 
• Watch Fund Fees: Check the expense ratio and any exit charges. Lower fees mean you get to keep more of your returns.   
• Diversify Across Debt Funds: Don’t put all your money in one type of debt fund. Spread it across different ones to reduce risk and balance your returns.   
• Stay Aware of Interest Rate Trends: Since debt fund returns are affected by interest rates, it’s helpful to follow basic news about rate changes. This can guide when to invest or switch between funds. 

If you want more flexibility, you can also explore ULIP offerings from Bandhan Life, where you can build wealth and get a life cover too!   

You may also consider iInvest Advantage — a ULIP that combines life insurance with market-linked returns for long-term goals 

Conclusion 

Debt funds are a great option to help you grow your money steadily, get regular income, and balance risk in your portfolio. They are also easy to access and can be more tax-friendly than traditional options like fixed deposits. 

By choosing the right type of debt fund and understanding the risks involved, you can make them a smart part of your financial plan.   

Learn more about Bandhan Life ULIPs to get started.  

Frequently Asked Questions 

1. How are debt funds different from equity funds? 

Debt funds invest in fixed-income products like bonds, while equity funds invest in stocks. Debt funds aim for stable returns with lower risk; equity funds aim for higher growth but come with more ups and downs. 

2. Are debt funds safe investments? 

Debt funds are generally safer than equity funds but not completely risk-free. They can be affected by interest rate changes and whether companies pay their dues on time. 

3. What risks should I be aware of when investing in debt funds? 

Key risks include the impact of changing interest rates, the chance that some companies may not pay on time, and sometimes a small delay in getting your money out during tough market periods. 

4. How do interest rates affect debt funds? 

When interest rates go up, bond values go down temporarily, which can lower returns. When rates fall, bond values go up, helping returns. 

5. How do I choose the right debt fund for my portfolio? 

Pick funds that match your investment time frame and comfort with risk. For short-term needs, use liquid or short-term debt funds. For long-term goals, consider long-term or dynamic bond funds. Check the fund’s past returns and quality of investments.