This informative article covering the subject of debt fund investments was contributed to Leisure Freak by Naina Rajgopalan.
What is the Meaning of Debt Fund?
Debt funds are managed by the fund managers in a way that they pose the lowest risk compared to other types of mutual funds. They are like banks’ fixed deposits but with a high return and tax benefit. Therefore they are ideal for middle-income groups and retail investors.
There are always two sides to a coin! With all the advantages of debt funds, there are also certain drawbacks. This post explains the pros and cons of debt mutual fund investment so you can make an informed decision.
5 Advantages of Debt Funds
Following are the 5 primary advantages of debt funds that make them a favourite amongst investors.
- Security of Investment
As the risk in debt funds is low, you get security and stability of income by investing in them. These steady returns help establish the financial goal and achieve it in expected ways. It is ideal for people who can’t put their limited funds at stake due to market risk.
- Low Transaction Costs
The mutual fund houses put a uniform transaction cost for buying a single unit of debt funds or buying in bulk. Therefore you can purchase multiple units at a meagre transaction cost. This is one of the significant benefits of debt funds against mutual funds.
- Suitability
Being low-risk, debt funds are ideal for short- and long-term investors. They have a high proportion of debt-related investment options. Therefore you can pull your investment whenever suitable to you without worrying about losses.
- Accessibility
You can easily access the amount in your debt funds in times of financial emergency as its liquidity is relatively high. It’s easily possible to get the amount in your debt fund to be transferred to your bank account within 1 or 2 business days.
- Taxation Benefits
Debt funds are not taxed every year. Tax is levied on the withdrawal of funds only. You also get the advantage of indexation and reduced tax on returns with debt fund investments.
5 Disadvantages of Debt Funds
There are some disadvantages of debt funds that you must know before investing in them.
- Default in Paying Interest
The institutes that hold the maximum size of debt funds investment are the reputed sectors like government securities, corporate deposits, and money market instruments. However, the risk of these institutes defaulting in paying the interest can’t be entirely eliminated.
- Lock-in period
You can take your amount out of debt funds anytime but not before your lock-in period. Generally, debt funds come with a 3, 5 or 8 years lock-in period. You may need to pay extra fees or penalties if you wish to withdraw your investment before the lock-in period.
- Low Returns
If you compare the interest rate of debt funds to equity funds, you will be disappointed. The debt fund risk is low because of the same reason for which the returns are low. 60 to 70 percent of the corpus of debt funds is invested in safe and low-interest schemes. Therefore the overall return is less.
- Various options
It’s not a con per se. But for a new investor who is still learning the meaning of debt fund, it’s daunting to choose amongst the plethora of debt funds available in the market. They all provide identical returns, and their terms and conditions are also similar.
- No Control
The fund managers manage the entire corpus of debt funds, keeping the low-risk factor a priority. Therefore, as an investor, you don’t have any control over which sector the manager chooses to park your money.
Conclusion
The advantages of debt funds outrun its drawbacks. Therefore despite these cons, financial experts never deny investing in debt funds. Also, a debt fund is one of the most appropriate low-risk options for medium-income groups.
High-return Investments in shares and stocks are risky for them. Whereas bank savings schemes such as fixed and recurring deposits offer too low returns to keep up with inflation. A perfect middle ground of reasonable return on investment and safety of your funds can be found only in debt fund investment.
Thank you Naina for sharing details on a subject that many who are seeking different ways to invest know little about.
Author Bio:
Naina Rajgopalan has a thing for numbers and a deep fascination to learn about all things finance. She’s been money-wise from a young age and has always shared her knowledge and tips with those around her. Being a part of the content team at Freo Save, a digital savings account that offers up to 7% interest rate on savings along with benefits such as insurance on balance, safe & secure banking, and so on. Naina stays updated with the latest of what happens in the banking and fintech industries. She has taken upon herself to share her knowledge with readers across all walks of life to help them manage their finances and budgets better, so they can make better decisions while spending, borrowing, investing and saving.