Debt funds are mutual funds that invest in fixed income securities like government and corporate bonds, corporate debt securities and money markets. These instruments are considered to be safer as the risks associated are less as well as the returns.

However, if you want more returns than banks with minimal risk this might be your financial instrument. These funds are considered to be one of the best financial instruments for budding investors due to their low volatility rate.

Taxation on debt funds

The dividends provided by mutual funds were previously made tax-free in the hands of investors until January 2020. The fund house was supposed to pay dividend distribution tax (DDT) at applicable rates before making the dividend payout to the investors. This was changed in the Union Budget 2020. The dividends are now taxed classically. Meaning, the dividends are added to your overall income and taxed as per the income tax slab you fall under.

The rate of taxation of capital gains depends on the holding period. If the debt fund units are sold within a holding period of three years, you make short-term capital gains. These gains are added to your overall income and taxed as per the income tax slab you fall under. You realise long-term capital gains on selling your debt fund units after a holding period of three years. These gains are taxed at a rate of 20% after indexation.

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Things to consider while investing in febt funds
 

Fund Objectives

Debt funds aim at optimizing returns by diversifying the portfolio by investing across a variety of securities. You can expect these funds to perform predictably. It is because of this reason that debt funds are suitable for conservative investors.

Fund Category

Debt funds are further classified under various categories such as liquid funds, monthly income plans (MIPs), fixed maturity plans (FMPs), dynamic bond funds, income funds, credit opportunities funds, GILT funds, short-term funds, and ultra short-term funds. These funds come with their own set of objectives to achieve and advantages. You have to assess your requirements and invest in a suitable debt fund.

Risks

Debt funds are subject to interest rate risk, credit risk, and liquidity risk. The fund value may fluctuate due to the movement in the overall interest rates. You have to assume these risks when you invest any debt fund plan.

Cost

Debt funds charge an expense ratio to manage your investment. No fund house can charge above the limit set by the Securities and Exchange Board of India (SEBI). The expense ratio varies across mutual fund plans.

Investment Horizon

An investment horizon of three months to one year is ideal for liquid funds. If you have a longer horizon of say two to three years, then you can explore short-term bond funds.
 

Financial Goals

Debt funds can be used to achieve a variety of goals such as earning additional income or for liquidity and earning much higher returns than a regular savings bank account. You have to ensure that your requirements are in with the objectives of the debt fund scheme you are choosing.

Top 10 debt funds

DSP Healthcare Fund

ICICI Prudential India Opportunities Fund Direct-Growth Plan

ICICI Prudential Ultra Short Term Fund

ICICI Prudential Multicap Fund

Aditya Birla Sun Life CEF

IDFC Government Securities Fund

Nippon India Nivesh Lakshya Fund

IDFC Government Securities Fund- Investment Plan

Aditya Birla Sun Life Government Securities Fund Direct Fund Plan-Growth Instant Gain

Nippon India Gilt Securities Fund