Mutual Fund: Imagine you have a big jar where you put your money. You know you’ll get it back later, right? Now, think of a debt mutual fund like a community jar where lots of people pool their money. These jars don’t just keep the money safe; they also lend it out to others, like banks or companies, who promise to pay it back later with a little extra, just as a thank-you. It’s similar to when you lend your toys to a friend and they give you some extra candy in return.
So, when you invest in a debt mutual fund, you’re essentially letting this big jar borrow your money for a while. And in return, they give you a little extra back when you need it, just like how you get some extra candy when you share your toys.
When you invest in a debt mutual fund, you become a part-owner of all the loans or bonds the fund has invested in. The money you get back usually comes from the interest payments made on these loans or bonds, and sometimes from any profit if the value of the bonds goes up.
Understanding the Inner Workings of Debt Mutual Funds
Debt mutual funds are a bit like a community piggy bank. Picture this: you and your friends each contribute some money into a shared jar. Instead of leaving that money untouched, you collectively decide to lend it out to people who could use a hand, like your friends who need to borrow board games or books. That’s the essence of debt mutual funds. A bunch of individuals pool their money into a larger fund. Instead of letting it gather dust, the fund manager puts it to work by lending it out to different borrowers, be it companies or even governments.
Types of Debt Mutual Funds Explained
- Overnight funds: These funds invest in very short-term instruments for just one day, hence the name “overnight” funds.
- Liquid funds: They invest in short-term debt securities with maturities ranging from 1 week to 91 days, ideal for investors seeking safety and liquidity.
- Low duration funds: Offering moderate returns with slightly higher risk than ultra-short duration funds, they invest in debt securities maturing between 6 months to 1 year.
- Ultra-short duration funds: These invest in debt securities maturing between 3 to 6 months, providing higher returns compared to fixed deposits with low risk.
- Money market funds: Capital is invested in money market instruments for short durations, typically up to a year.
- Short duration funds: Investing in short-term government and corporate bonds, these funds have maturities ranging from 1 to 3 years.
- Medium duration funds: Similar to short duration funds but with maturities ranging from 3 to 4 years.
- Medium to long duration funds: Invest in debt securities with maturities from 4 to 7 years, carrying slightly higher interest rate risk.
- Long duration funds: Invest in long-term debt instruments with maturities exceeding 7 years, posing higher risk but lower than equity mutual funds.
- Corporate bond funds: Primarily invest in corporate bonds with high credit ratings, suitable for cautious investors seeking safe debt funds.
- Banking and PSU funds: Invest mainly in instruments issued by banks, PSUs, and PFIs, providing stability and security.
- Gilt funds: Invest predominantly in government securities with low default risk but higher interest rate risk.
- Dynamic funds: Invest based on prevailing interest rate movements, with the portfolio adjusted accordingly by the fund manager.
- Floater funds: Allocate a minimum percentage into floating-rate bonds, whose interest rates change with market fluctuations.
- Gilt fund with 10-year constant duration: Specifically invest in government securities with a constant duration of 10 years.
- Credit risk funds: Primarily invest in debt instruments with lower credit ratings, aiming for higher returns by taking on higher credit risk.
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