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Tata Capital > Blog > Wealth Services > How Debt Mutual Funds Benefit in your Portfolio

Wealth Services

How Debt Mutual Funds Benefit in your Portfolio

How Debt Mutual Funds Benefit in your Portfolio

Debt mutual funds are funds that invest in fixed-income instruments such as corporate and PSU companies’ bonds, government bonds, commercial paper and so on. Investors put their money in debt funds as a hedge against volatility in the capital markets. While equity investments can shoot up or plunge quite rapidly, debt funds are a stable refuge to build a strong moat one can rely on in choppy markets.

Let’s take a look at the major advantages of having debt funds in your portfolio:

1. Extremely liquid investment

Investment in a debt mutual fund is considered more liquid than even fixed deposits. While you can cash in on your debt fund investment on a day’s notice, breaking your FD could take more time since it generally involves some paperwork rather than just a tap on your phone screen or the click of a mouse. Moreover, you can liquidate a debt mutual fund SIP without attracting any charges from a fund house whereas a bank will levy a penalty for withdrawing your FD money before maturity.

Now mutual funds also provide an instant liquidity option under the instant redemption facility in liquid funds for withdrawals up to Rs 50,000

Additional Read: What are the benefits of investing in Liquid Funds?

2. Tax benefits are better

Investing in a debt mutual fund is more beneficial on the tax front in the long run than an equity investment or a fixed deposit. Returns from an equity scheme will attract a short term capital gains tax of 15% if the investment is sold before a year and long term capital gain tax of 10% for investments sold after a year. If debt mutual fund investments are sold before three years then the returns are added to the total income and taxed as per the applicable income tax slab.

Capital gains are taxed at the marginal tax rate i.e. the gains are added to the total income and taxed as per the applicable income tax slab. While holdings greater than 3 years will be able to reap the benefit of indexation which is not available in equity. In Indexation your capital gains are adjusted with respect to inflation and then taxed. As such the longer you hold your debt mutual fund investment, the greater will be the benefit from indexation.

If your FD returns amount to more than Rs 10,000 then the bank will deduct TDS. Moreover, returns from an FD are taxed every year whereas that from a debt fund is taxed only on withdrawal.

3. Better returns compared to peers

Investment in debt funds could earn you higher return on capital than other debt options like bonds and fixed deposits. While bond yields and FDs are dependent on interest rates set by the central bank, debt funds put your money in a motley combination of debt instruments such as commercial papers, corporate and PSU bonds etc. that may not suffer a first order impact of frequent rate changes.

Another important merit to consider is that debt funds can work to your advantage in both interest rate scenarios — when it’s rising and when it’s falling.  This can be achieved by selecting the funds that benefit in these scenarios. For example, dynamic/ duration funds can benefit from falling interest rates while accrual funds can be better in a rising interest scenario.

4. Flexibility

If you invest in a debt fund SIP, you could devise an SWP (systematic withdrawal plan) to regularly take out an amount from the investment. This SWP option is also more tax efficient for investors who need regular income and are in higher tax brackets instead of dividend options.

There’s also the flexibility to shift your money to a different scheme in the same fund house if you think the markets are going in a particular direction and are expected to stay the course for the time being. This can be done to invest in equity funds systematically from liquid/debt funds.

5. Money never sleeps

If you invest in a fixed deposit account or bonds, the money either tends to get used after the term of the investment or it stays idle until you decide where to invest it. The advantage in an open ended debt mutual fund investment is that the money will never be idle and grow each day.

Additional Read: Advantages of Having Debt Mutual Funds in Your Portfolio

Planning your debt fund investment

Whether you have a low or high appetite for risk, debt funds serve an important role to balance a portfolio. It ensures that the low risk investor has money parked in an avenue where it is growing in a stable manner and can be redirected at short notice if the markets are on an upward swing. Moreover, if you have a low risk appetite then you can also use it as an easy fallback option.  For an investor with a high risk appetite, a debt fund can be used to absorb shocks from volatile equity market conditions.

It is a good idea to periodically switch funds from growth investments like equity to lower risk debt mutual funds. This lends some much needed balance to the portfolio as financial goals appear on the horizon. The investor stands to benefit on both ends when using it as a periodic exit or investment strategy. While the risk of cashing in on investments from an equity MF when its value is low is avoided, the periodic strategy tends to minimize the blow from a high entry point to a large extent.


Debt funds are considerably low-risk mutual funds and can be opted for by risk averse investors as well as aggressive investors. While the conservative and a balanced investor should have it in their portfolio, growth and high growth investors should keep it to absorb the shocks of the equity market. Whether you want to plan for your retirement or invest to achieve a financial goal such as a house or a trip abroad, Tata Capital Wealth Management Solutions can help you achieve it with the right mix of debt fund investments, equity investments and other categories based on your needs and priorities.

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