For any business to grow and flourish, two goals are quintessential -wealth creation and saving taxes. There are multiple financial instruments available for businesses and corporations that can help them to create wealth and lower their tax liabilities. Mutual funds investments are one such financial instrument that can pump up the wealth creation process for businesses. There are different types of mutual funds that businesses can consider for investing such as equity funds, ELSS funds, debt funds, etc.
In this blog, we are going to discuss what debt funds are and how they work.
What are Debt Funds?
Debt funds are quite easy to understand. Imagine you are a business owner seeking a loan to run your business. Now you will probably go to a financial institute to ask for a loan. And that institution will lend you a sum of money in exchange for some security or collateral.
Similarly, when you invest in a debt fund, you are lending money to an entity that promises to give you a fixed amount of interest at regular intervals. The interest is cumulated and can be yielded monthly, quarterly, half-yearly, annually depending on the investment period.
Debt funds are also known as “fixed-income” securities because there’s a fixed interest rate decided by the issuer of the debt fund. The primary objective of investing in a debt mutual fund is capital protection. By investing corporate money in debt funds, businesses can ensure a steady income and capital appreciation.
How do Debt Funds work?
To understand how debt funds work, there are a couple of terms you need to be familiar with.
An important one is Credit Rating.
As you know, there are two parties involved in a debt fund security: the issuer and the entity that is seeking the debt. Now, the entity has to pay a pre-decided interest as well as the principal amount upon maturity of the debt fund. Sometimes, the entity fails to pay back the interest and principal amount within the given period and become a defaulter. Credit Rating refers to the likelihood that a debtor will turn out to be a defaulter. Credit ratings can be high or low. A high credit rating signifies that the entity is more likely to pay the interest and principal amount on time. On the other hand, a low credit rating signifies a higher risk of payment default by the entity.
So now let’s get back to the original question: how do debt funds work? Based on the credit ratings, debt funds invest in various securities. A debt fund manager strives to invest in securities with higher credit ratings to ensure minimum volatility for the investors.
Why should businesses invest in Debt Funds?
The answer to why businesses should invest in debt funds is quite simple; security and wealth creation. Debt funds have a fixed rate of return that the investors get periodically. Also, investors receive the principal amount that they have invested along with the accumulated interest upon maturity. This makes debt funds a secure and regular source of wealth for investors.
Debt funds are suitable for conservative investors because they can earn decent returns without much risk. The returns received on the debt funds are usually between 7 to 9 per cent, higher than a bank’s fixed deposits. Businesses can invest in short-term (3-12 months) or medium-term (3-5 years) debt funds to enjoy good returns upon maturity.
Types of Debt Funds:
Based on the maturity period, these are the types of debt funds:
- Liquid Funds: Liquid funds are almost no-risk debt funds that work as the best alternative for bank savings accounts. Liquid funds focus on investing in the debt instrument with a maturity period between 1 to 90 days. In this short period of 1 to 90 days, liquid funds hardly see any negative returns while yielding higher returns than your bank’s savings account.
- Income Funds: As the name suggests, income funds emphasize higher interest rates and invest predominantly in debt securities that have a longer maturity period. The average maturity period of income funds usually lies between five to seven years.
- Dynamic Bond Funds: Like other debt funds, dynamic bond funds do not have a defined mandate. That means an investor gets the flexibility to invest in long-term or short-term funds based on the rising or falling interest rates of the debt instrument. With the ability to switch between long-term and short-term funds, the investors can take the advantage of the fluctuating interest rate of the instrument.
- Gilt Funds: The gilt fund instrument only invests in government securities. These are almost absolutely safe funds and ideal for conservative investors as the government hardly ever defaults on the loans it has obtained through the debt instruments. These funds are quite high-rated securities with almost no credit risk.
- Short and Ultra-Short Term Funds: Short and ultra-short funds consist of one to three years of maturity period and they also rarely observe much risk and fluctuations during this tenure. Therefore, they are ideal for conservative business investors.
Benefits of investing in Debt Funds:
Here are the benefits that businesses can seek by investing in debt funds:
- Stable Returns: This one goes without saying that due to a fixed interest rate, the investors can be rest assured of receiving stable returns until the maturity period. If you are a business owner that wants to achieve a certain financial goal within a limited time frame or have a low appetite for risk, then debt funds can be the most suitable investment option for you.
- Flexibility: Whether you want to invest overnight or for 10 to 15 years, you can do it with debt funds. The maturity period is the main differentiator of different debt funds. So you can easily find overnight and long-term debt funds and invest according to your financial goals.
- High-Liquidity: There’s no mandatory lock-in period like bank fixed deposits for debt funds. You can in-cash your debt fund investment whenever you want to. This empowers businesses by providing them with a source of cash in case of emergency expenses.
- Lower Fees: Apart from being low-risk and yielding good returns, debt funds also have a lower transaction fee as compared to other mutual funds like equity funds. There’s no TDS on debt funds, however, a sum of tax is deducted when you decide to sell the fund units, which is calculated according to the maturity period of a debt fund.
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- An overview of all your investments in one place.
- AI-based recommendations to invest your idle cash efficiently.
- Diversify your investment portfolio through different contingency, growth and liquid funds, and a lot more.
To unlock all these benefits, all you need to do is set up a mutual fund account with Shootih, fill in the mandatory details and start investing! So what are you waiting for? Explore Shootih and unlock the multiple benefits of investing for your business.