How to start investing in debt mutual funds – a primer

Published: August 5, 2022 at 6:00 am

Last Updated on August 6, 2022 at 4:04 pm

This article lists the essentials an investor needs to keep in mind before selecting debt mutual funds.

(1) Debt mutual funds are not replacements for fixed deposits! Do not take product manufacturers (AMC guys) and sales guys seriously! A fixed deposit in a bank too big to fail has a risk so small that it can be reasonably approximated to zero. A debt mutual fund is a market-linked product. The NAV of a debt mutual fund reflects the current market price of the bonds in the portfolio.

This means we have no idea how the NAV will move and what the returns will be. Sometimes it can be higher than FDs, and sometimes not. If you cannot accept this hard reality, then debt mutual funds are not for you.

Debt mutual funds have tax advantages over fixed deposits when held for more than three years. However, care is required in the selection and understanding of risks.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥

(2) The bond market is getting more and more popular. This means speculation has increased, and NAV movement will be determined by demand vs supply forces only. Theoretical ideas on how NAV will change will interest rate moves are just that – theoretical. We must appreciate and accept that such forces will result in sudden NAV up or downswing in any debt fund (incl liquid or overnight funds).

(3) A stock market crash will also affect the bond market (and vice-versa). Any sudden bad news will result in people selling bonds or not buying any more. This will adversely affect debt fund NAV.

(4) Never chase returns in debt funds. Never look at star rating or past performance to buy debt funds. The higher the return they offer, the more risk they have taken. This can risk can be classified into two broad categories.

  • Credit risk: Ironic as it sounds, we expect higher interest from weaker businesses. So an A-rated bond will offer higher returns than an AAA-rated bond. The catch is that the A-rated bond issuer has a weak business, and their repaying capacity is lower and can further worsen.
  • If a bond issuer defaults, the NAV of a debt fund will fall vertically and not recover until they repay. In the meantime, if the AMC sell the bond, the loss is permanent. Bonds issued by the govt cannot be classified in terms of repaying capacity for resident investors. They are simply called “sovereign” bonds. We just hope they will not fail; else, our problems will be much more than poor debt fund returns!
  • Interest rate risk or duration risk: Higher the duration of a bond, the more volatile its price. This is because (for example) no one wants to be stuck with a long-term bond with rates increasing. All bonds have interest rate risk, whether issued by corporates or the govt.

(5) Simple thumb rules (technical): If your need is after X years, the average portfolio maturity of the (open-ended) debt fund portfolio should be much lower than X. Also, looking at the portfolio, one should check how much risk the fund is taking. Our monthly debt mutual fund screener helps in this regard: Debt mutual fund screener (July 2022) for selection, tracking, and learning.

(6) Simple thumb rules (non-technical) Stick to short-term funds with low credit risk like liquid funds or money market funds for goals less than five years away. Those uncomfortable with NAV volatility can use these funds for longer-term goals too.

Arbitrage funds typically have NAV volatility similar to debt funds. Those comfortable can consider these. They may not offer much in the way of returns but are a bit more tax efficient than debt funds as they are considered equity funds. See: How Arbitrage Mutual Funds Work: A simple introduction.

Funds like corporate bond funds or gilt funds can be considered for long-term goals with a proper asset allocation and regular rebalancing. Please note that these funds can take on credit risk (esp. corporate bond funds).

For fund recommendations, see: Handpicked List of Mutual Funds Jul-Sep 2022 (PlumbLine).

All other types of debt mutual funds can be avoided! For a list, see: List of Mutual fund categories that you can avoid!

Do share this article with your friends using the buttons below.

🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
Follow Freefincal on Google News
Follow Freefincal on Google News
Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.
Subscribe to the freefincal Youtube Channel.
Follow freefincal on WhatsApp Channel
Follow freefincal on WhatsApp
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth! 
Listen to the Lets Get Rich with Pattu Podcast
Listen to the Let's Get Rich with Pattu Podcast
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
Lets Get RICH With PATTU podcast on YouTube
Let's Get RICH With PATTU podcast on YouTube.
🔥Now Watch Let's Get Rich With Pattu தமிழில் (in Tamil)! 🔥
  • Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
  • Have a question? Subscribe to our newsletter using the form below.
  • Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!

About The Author

Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both the boy and girl-version covers of "Chinchu Gets a superpower".
Most investor problems can be traced to a lack of informed decision-making. We made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So, in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it, as well as teaching him several key ideas of decision-making and money management, is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)