Debt funds are ideal for investors who aim for a regular income but don’t want risky investments. If you are looking for a low-cost structure with stable returns and high liquidity, then debt funds are for you.
A debt fund is a pooled investment that holds debt securities, such as bonds and other fixed-income instruments. They are normally used as a portfolio diversification strategy and they can be purchased through mutual funds or brokerage companies.
How they work
Debt funds (also called bond funds or fixed-income funds) invest in some debt securities in one pooled investment. This way, an investor will buy one debt fund and get exposure to many different types of bonds, such as corporate bonds, US Treasury bonds, municipal bonds and foreign bonds.
Bonds are debt obligations issued by an organization (corporations or governments). When you buy a bond, you are lending your money to the entity for a fixed period. In return, they will pay interest. At the end of that period, known as the maturity date, you will receive your initial loan plus interests.
When you invest in a debt fund, instead of holding a bond, you hold a share of the fund itself. The interest you gain, known as the yield, is a reflection of the combined earning rates of all the underlying bonds of which the fund is composed of.
One of the main differences between a bond and a debt fund is the maturity. While you hold bonds until the maturity date, which can be up to 30 years, debt funds are held just for as long as it suits your investment goal.
When holding bonds to the maturity date, in the worst-case scenario you get your initial investment back (if market fluctuations are bad by the time it reaches its maturity). As debt funds don’t have a maturity date, if it is worthless when you sell it you won’t get your initial investment back, so you need to track its value before you decide to sell.
Debt funds are ideal investments for people trying to diversify their portfolio. Some investors buy debt funds as a source of income in retirement. Take your time to explore all the available options so you can decide which investment plan suits you best.