Debt Funds

How do debt funds work?

Governments or corporations can borrow money from investors via debt instruments such as bonds. Investors earn on these debt instruments through interest payouts and principal repayment at the end of the tenure. The returns tend to be relatively stable if the borrower has a high credit rating or is a government institution. However, returns are linked to market movements, including interest rate movements.

Debt mutual funds invest in a diversified portfolio of debt or fixed-income instruments. Such funds may invest in short-term, medium-term, long-term fixed income instruments or a combination of these, depending on the scheme category and investment objective.

Who should invest in debt funds?

Debt funds are suitable for a wide range of investors, including those with a conservative risk appetite, retirees, or individuals looking for steady income streams. Most debt funds are also usually liquid, so they can be a good avenue for an emergency corpus. The relative stability and modest return potential also make them suitable for short-term investments as compared to equity, which has a higher return potential but is recommended for longer investment horizons.


Before choosing a debt fund, investors should consider the credit quality of the underlying bonds within the fund's portfolio. Higher-rated bonds typically offer lower yields but come with lower credit risk, while lower-rated bonds may provide higher yields but carry increased credit risk. Additionally, investors should evaluate the fund's average maturity and duration, as these factors influence sensitivity to interest rate fluctuations.