The Best Debt Funds to Invest in India for 2021

What are Best Debt Funds?

Debt funds majorly invest in fixed interest-earning instruments such as treasury bills and certificate of deposits. The main intention of these funds is to generate wealth in the form of interest income and steady appreciation of the capital invested in the long run. The underlying assets generate a fixed rate of interest over the tenure for which investors stay invested in the fund.

A debt fund manager invests predominantly in the underlying assets based on their respective credit ratings. A higher credit rating indicates that debt security has a higher chance of paying interest regularly along with the repayment of the principal upon expiry of the investment tenure. Apart from that, the fund manager aligns his investment strategy as per the interest rate movements.

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Who Should Invest in Best Debt Mutual Funds?

Debt funds are suitable for risk-averse or for those who are not ready to have equity exposure. Debt funds grow investors’ wealth with little to no risk. Additionally, these funds strive to provide regular income. Investors usually stay invested in debt funds for a short to medium-term horizon.

You need to choose an appropriate debt fund as per your investment horizon. Liquid funds may be suitable for a short-term investor who generally parks his or her surplus funds in a savings bank account. Liquid funds provide returns in the range of 7-9%. They also offer flexibility in terms of withdrawals at any time, just like a regular savings bank account.

If you need to ride the interest rate volatility, then dynamic bond funds may be an ideal option. These funds are suitable for a medium-term investment horizon to earn higher returns than a 5-year bank FD.

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List of Top 10 Best Debt Funds to invest in India for 2021

  1. Sundaram Gilt Fund – Regular Plan
  2. ICICI Prudential Long Term Fund – Regular Plan
  3. SBI Magnum Gilt Fund – Long Term Plan
  4. L&T Gilt Fund – Investment Plan | Invest Online
  5. IDFC Government Securities Fund – Short Term Plan – Regular Plan
  6. Tata Dynamic Bond Fund – Regular Plan
  7. IDFC Government Securities Fund – Provident Fund Plan – Regular Plan
  8. Tata Gilt Mid Term Fund – Regular Plan
  9. Birla Sun Life Medium Term Plan
  10. UTI Gilt Advantage Long Term Plan

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Top long/medium term debt funds :

  1. HDFC Medium Term Opportunities Fund
  2. Aditya Birla Sun Life Treasury Optimizer Fund
  3. ICICI Prudential Banking & PSU Debt Fund
  4. ICICI Prudential Income Opportunities Fund
  5. Kotak Income Opportunities Fund
  6. DSP BlackRock Income Opportunities Fund
  7. Aditya Birla Sun Life Medium Term Plan
  8. SBI Corporate Bond Fund
  9. Reliance Regular Savings Fund – Debt Option
  10. Franklin India Corporate Bond Opportunities Fund

Top Short term debt funds :

  • 1. Aditya Birla Sun Life Short Term Fund
  • 2. HDFC Short Term Opportunities Fund
  • 3. ICICI Prudential Short Term Fund
  • 4. Reliance Short Term Fund
  • 5. Kotak Bond – Short Term
  • 6. SBI Short Term Debt Fund
  • 7. Franklin India Short Term Income Plan

Types of debt mutual fund

There are many types of debt mutual funds depending on the interest rate and maturity. An investor who wishes to invest in debt mutual funds must also consider which type of fund is most suitable for his investment terms.

The different types of debt mutual funds are listed below:

  1. Overnight Fund
  2. Liquid Fund
  3. Ultra Short Duration Fund
  4. Money Market Fund
  5. Short Duration Funds
  6. Medium Term Funds
  7. Long Duration Fund
  8. Dynamic Bond Fund
  9. Corporate Bond Fund
  10. Credit Risk Fund
  11. Banking and PSU Fund
  12. Gilt Fund
  13. Income Fund

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Top 10 Best Debt Mutual Funds in India

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Our team of world-class advisors from Wealth First helped us build this list based on their mutual fund selection process, undertaken using two parameters:

Qualitative Parameters:

  • AMC comfort – Pedigree, Credibility, Compliance, Process and Ability to Retain Top Management & Talent
  • Fund Manager comfort – Experience, Reputation, Performance and Continuity Record (We have had 170+ investment and marketing team interactions in the last 1 year)

Quantitative Parameters:

  • Scheme Aesthetics – Fund Size & Recent AUM Growth, Concentration Analysis, Clarity of positioning
  • Performance – Historical performances (SIP, Last 20-Quarters, 3-Year, and 5-Year Numbers), Risk-adjusted returns, Sharpe, Beta, and Other Statistical Ratios
  • Negative Criteria – Cash Calls, Outlier Performances, Recent Management Changes, etc.

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What are the Advantages of Investing in Debt Mutual Funds?

Below are the advantages of investing in debt mutual funds:

  1. Debt mutual funds carry less risk than equity funds, this scheme is ideal for an investor seeking stability
  2. These funds are highly liquid and an investor can anytime convert his investment into cash quicker than any other comparable investment option.
  3. The amount invested in debt mutual funds can easily be transferred to an equity mutual fund or any other scheme as per an investor’s choice. Such options are not available in other investment options. Example- FD can be closed but cannot be transferred
  4. Higher potential returns as compared to FD rates and saving account interest rates
  5. When a debt mutual fund is combined equity mutual funds, a portfolio is more stable due to diversification

Risks in Debt Funds Investing:

The two main risks from investing in a Debt Fund are:

Investing in debt funds can be considered an ideal alternative for people with low-risk appetite who do not wish to invest in equities due to the level of volatility involved. Debts funds basically invest in fixed income instruments – government bonds, certificate of deposit, commercial papers, treasury bills and corporate bonds.

Risks in Debt Funds Investing

Investing in debt funds typically carries these risks –

Credit Risk – It is the risk of default when borrower fails to make required payments. A default in a portfolio may impact the fund. A corporate bond with an AAA rating is considered of the highest quality.

Interest Rate Risk – Rate of return in debt funds is inversely correlated to interest rate. Suppose, a bond is priced at Rs 90 and the interest rate is 8%. If the RBI slashes interest rates by 50 basis points to 7.5%, the price of the bond will move up. Similarly, if the interest rate is increased, the price of the bond will fall.

best Debt funds to invest for 2021

Inflation Risk – As the price of goods and services increase every year, it becomes necessary to find investments which give higher return than inflation. Suppose interest rate is 7% and inflation is 9%. in this case, real income of investor is -2%.

Investors should be mindful on the papers which the scheme invests in. Some schemes may invest in low-rated papers to generate better returns. So a conservative investor can look to avoid investing in such schemes.

Hence, it is incorrect to assume Debt Mutual Funds are as safe as bank fixed deposits.

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Taxation of Debt Fund

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 an Investor Should Consider While Investing in Debt Funds

The following are some of the factors that must be considered before investing in debt funds.

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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.

Debt Mutual Funds mainly invest in a mix of debt or fixed income securities such as Treasury Bills,Government Securities, Corporate Bonds, Money Market instruments and other debt securities of different time horizons.

How do Debt Funds Work

Debt funds are a type of mutual fund that generate returns from their investors’ money by investing in bonds or deposits of various kinds. These terms basically mean that they lend money and earn interest on the money they have lent. This interest that they earn forms the basis for the returns that they generate for investors.

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How do debt mutual funds work

  • A bond is like a certificate of deposit that is issued by the borrower to the lender. Even individual investors do something similar when they do something as simple as make a fixed deposit in a bank. When you make an FD with a bank, you are basically lending money to the bank. You can also buy bonds, for example the tax-rebate bonds issued by various companies like REC and HUDCO.
  • This is exactly what debt funds do, except for a few differences. One, they are able to invest in many types of bonds that are not available to individuals. For example, the Government of India issues bonds. It is in fact, by far the largest borrower (and thus bond-issuer) in the country. Bonds are also issued by many large and medium sized businesses in the country. Mutual funds also invest in these.
  • A simple way of understanding debt funds is to think of them simply as a way of passing through the interest income that they receive from the bonds they invest in. There are a couple of further complexities to this.
  • One, unlike the FDs that individuals invest in, mutual funds invest in bonds that are tradable, just like shares are tradable. The way there’s a stock market where shares are traded, there’s also a debt market where bonds of various types are traded.
  • Two, on this debt market, the prices of different bonds can rise or fall, just like they do on the stock markets. If a mutual fund buys a bond and its price subsequently rises, then it can make additional money over and above what it would have made out of the interest income alone. This would result in higher return for investors. Obviously, the opposite is also true.
  • But why would bond prices rise or fall? There can be a number of reasons. The major one is a change in interest rates, or even the expectation of such a change. Suppose there’s a bond that pays out interest at a rate of 9 per cent a year. Then, the interest rates in the economy fall and newer bonds start getting issued at 8 per cent. Obviously, the old bond should now be worth more than earlier. After all, a given amount of money invested in it can earn more money. Its price would now rise. Mutual funds that hold it would find their holdings worth more and they could make additional profits by selling this bond. Again, the reverse could happen when interest rates rise. Despite the expectation of safety, such a situation could actually result in some losses for a bond fund.

A debt fund is a type of mutual fund which invests most of the money gathered from investors into fixed income instruments like corporate bonds, government bonds (both state and central), bonds issued by banks, certificate of deposit, treasury bills etc. These mutual funds are best for investors who are risk avoiding in nature and do not wish to invest in stock market.

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Fixed deposit vs Debt mutual fund

Investment in debt mutual funds is a much better option than parking your money in bank FDs. Let us look in major reasons for this.

1. Returns on Investment:

After demonetization, many banks lower the FD rates due to excessive liquidity. State Bank of India (SBI), for example, currently offers 6.9 % for 1-year deposits, compared to 8% in 2015. For a 3 year deposit, it is even lower at 6.60%.

Debt funds have historically given returns in the range of 7-9% per annum.

As the returns of debt funds demonstrate, you can beat the banks by investing in debt funds. Debt fund investors assume both credit risk and interest rate risk and are hence compensated by higher returns.

2. Taxation:

The big difference between this two low-risk investment instruments is that of taxation.

In case of Fixed Deposits (FD):

The interest earned from FDs is added to your annual income for taxation purposes. Hence, the tax rate on interest earned from FDs will depend on your income tax slab, i.e. 5 %, 20 % or 30 % on the interest received.

For example, if your annual income, after including interest earned from your FDs, falls within the 30% tax bracket, the interest component will attract 30% income tax. Since many investors are in the top tax bracket, this takes away a large chunk of their returns.

In case of Debt Funds:

Taxes upon debt mutual funds are of two types depending upon the period for which they are held. These two types are:

Short-term Capital Gain Tax:

This is applicable to debt mutual funds held for a period of 36 months or less i.e. anything less than 3 years. In short-term capital gain tax, tax on funds is calculated as per income tax slab of the individual, i.e. 5%, 20% or 30% on the amount of gain.

Long-term Capital Gain tax:

This is applicable to debt mutual funds held for a period of 36 months or more i.e. anything more than 3 years. In long-term capital gain tax, tax on funds is calculated at the rate of 20 % with cost indexation on the amount of gain.

Indexation is the adjustment of your purchase price with respect to the effect of inflation in an economy and helps you to pay low taxes on your capital gain.

Thus, even if a bank FD and a debt fund generate the same rate of return, the debt fund will still generate a higher post-tax return, provided you come under 20% or 30% tax bracket and your investment horizon is more than 3 years.

3. Tax Deducted at Source (TDS):

Apart from above mention taxation, banks also deduct TDS on interest income from fixed deposits. It was introduced to collect tax at the source from where an individual’s income is generated.

As per the Income Tax Act, any company or person making a payment is required to deduct tax at source if the payment exceeds certain threshold limits. TDS has to be deducted at the rates prescribed by the tax department.

As a resident Indian, there will be no TDS when you sell/redeem your debt fund units. You are required to show the income and pay taxes, if any when you file your returns.

4. Liquidity

Turning to liquidity, open-ended debt funds proceeds are credited within a period of 2-3 working days depending on factors such as whether an Electronic Clearing Services (ECS) mandate is registered. FDs are also typically available at 1-2 day’s notice, but usually, carry a penalty if they are redeemed before the maturity date.

Banks penalize premature withdrawal of FDs by paying lower interest rate than the original booked interest rate. Premature withdrawal is however not allowed in tax saving fixed deposits as they have a lock-in period of 5 years.

Most banks currently deduct 1% from the original booked rate or 1% from the original card rate applicable for the period for which the FD has been in force, whichever is lower. These may adversely impact your FD’s effective rate of return in case of pre-mature withdrawal during emergencies.

Debt mutual funds, other than Fixed Maturity Plans, do not restrict redemption. However, many funds charge exit loads, ranging from 0.25–1% of the redeemed amount, if they are redeemed within a pre-specified period. Such periods can range anywhere from 15 days to 6 months. Ultra short-term and many short-term funds do not charge exit loads. Such debt funds will suit best to park your emergency fund.

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So these are some important comparison between the debt funds and FD.

Frequently Asked Questions

Is it safe to invest in debt funds?

Yes, it is a relatively safe option to invest in debt mutual funds. Debt funds invest in government securities, corporate bonds, fixed income generating instruments Historically, these funds have provided a regular income with moderate to low risk on the invested amount.Why are debt funds better than fixed deposits?

There are two reasons why debt mutual funds are considered a better option to invest than FD or saving account. Firstly, debt mutual funds do not have a lock-in period like FD. Secondly, historically debt mutual funds have delivered higher returns than FD rates.What is the average maturity of debt funds?

Maturity is the time period for which the amount is invested in the scheme and on the expiry of this maturity period, the principal amount invested is redeemed. On average, the maturity period of debt funds is 5 years. However, an investor can choose to invest in schemes with any maturity periodDo debt funds have a lock-in period?

Debt mutual funds do not have a lock-in period, an investor can choose to withdraw anytime.

Advantages of Debt Funds

The following are some of the most significant advantages of investing in debt funds:

  • Not influenced much by market movementsThe performance of debt mutual funds are not influenced much by the market movements. Hence, these funds are less volatile as compared to equity funds. The portfolio of debt funds is mostly constituted with fixed-income securities.
  • Stable portfolioSince the fund invests in fixed-income securities, the returns offered by debt mutual funds are much stabler. Therefore, risk-averse investors should consider investing in these funds.
  • Best for first-time investorsFirst-time investors may consider investing in debt funds to get started with their investment journey. This gives them the much-needed glimpse of what mutual funds are capable of.
  • Best option to park surplus fundsSince debt funds are highly liquid, you can consider investing your surplus money in these funds and earn much higher returns than a regular savings bank account.


Many times, investing in debt funds becomes complex. In case you don’t possess enough financial knowledge and are finding it too difficult to understand, then just reach out to us. We offer handpicked funds from experts.

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