What is a Debt Fund?

Published by Thomas Herold in Investments, Trading

'Debt Fund' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

A Debt Fund refers to an investment pool. This might be either an exchange traded fund or a mutual fund. In it the core assets will be various types of fixed income investments. They could choose to invest in longer term bonds or shorter term ones, money market instruments, securitized products, or even floating rate debt. The debt funds feature lower fee ratios on average than do the comparable equity funds. This is in part because the total management costs prove to be significantly lower for the debt funds than for the equity funds.

The primary objectives for investing in a debt fund will commonly be the generation of income as well as preservation of the original capital. They often consider their performance against a comparable major benchmark as a means of measuring success and judging absolute returns with these debt funds. As such, they will invest in as many promising opportunities as they can find. This might include MIP’s monthly income plans, liquid funds, STP’s short term plans, Gilt funds, and FMP’s fixed maturity plans.

In general, these debt funds will be preferred by those investors who do not want to experience scary high volatility which investing in the stock market easily often can present. It means that such a debt fund will deliver low but steady income as compared to equity funds. Yet the volatility is minor by comparison. Debt funds like these provide a number of advantages.

The tax rules have changed to favor them. Investors will have to stay invested for minimally three years in order to enjoy the advantage of lower taxed longer term capital gains. Those which are redeemed in under three years will be treated as ordinary income for taxable purposes. Debt funds thus become far more tax efficient than even fixed deposits when investors hold them for at least three years. Debt funds will only be taxed at the rate of 20 percent once they are indexed, which is often considerably lower than many investors’ otherwise earned income tax rate.

There is also no tax deduction for debt funds at the source, known as TDS on any and all gains which they realize. The returns also are linked to the market performance though they do not offer corresponding returns. When interest rates rise, they can lose, though it is a remote chance of them losing. The maturity of the various holdings defines the actual volatility of the debt fund. Those funds which mostly hold shorter term bonds will not demonstrate much volatility and will still provide returns that are approximately equal to the prevailing interest rates.

Debt funds also allow individuals to invest in SIP’s. These are the smartest ways to purchase equity or debt funds. With large sums, they can be sunk into a debt fund that will make systematic transfers into the plan or any fund for which an individual opts. Each month, a fixed and predetermined sum will move from the debt fund over to the other funds that the investors selected.

There will also be an exit load on debt funds. This is the tradeoff for vastly greater liquidity than with many competing investments. Individuals are able to withdraw at any point with only a day’s notice. Some of the funds do assess a penalty for leaving in under a preset minimum period. Exit loads range from a reasonable .5 percent on up to a steeper two percent penalty. The minimum holding period is often anywhere from six months on out to as long as two years.

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The term 'Debt Fund' is included in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.