Bonds and debt mutual funds provide a low-risk, stable investment option and help reduce overall portfolio volatility. Here’s a beginner-friendly breakdown:
1. What is a Bond?
- Definition: A bond is a loan given by an investor to a borrower (e.g., a corporation, government) for a specific period, with fixed interest payments (coupon).
- Comparison to Fixed Deposits:
- Bonds are tradable in secondary markets, unlike FDs.
- Risk levels vary depending on the issuer and bond type.
2. Key Bond Attributes:
- Face Value:
- Original price of the bond, repaid upon maturity.
- Coupon Rate:
- Fixed interest paid, typically annually or semi-annually.
- Maturity:
- Time when the borrower repays the principal to the investor.
- Market Price:
- Fluctuates based on market conditions and interest rates.
- Credit Rating:
- Indicates the issuer's creditworthiness (e.g., AAA = highest).
- Yield to Maturity (YTM):
- Expected return if held until maturity.
- Modified Duration:
- Measures sensitivity to interest rate changes (higher = more sensitive).
3. Types of Bonds:
- Government Bonds:
- Issued by central/state governments; risk-free for domestic investors.
-
Examples: Treasury Bills (short-term), G-Secs (long-term).
-
Corporate Bonds:
- Issued by private corporations or PSUs.
-
Higher returns but riskier than government bonds.
-
Special Bonds:
- Floating-Rate Bonds: Interest adjusts with market rates.
- Zero-Coupon Bonds: No interest; sold at a discount.
- Convertible Bonds: Can be converted into equity.
- Perpetual Bonds: No maturity, pay interest indefinitely.
- Inflation-Indexed Bonds: Adjusted for inflation (hedge against rising costs).
- Sovereign Gold Bonds (SGBs): Linked to gold prices; risk-free gold investment.
4. Debt Mutual Funds:
- Debt funds invest in a mix of bonds with varying durations and types.
- Advantages:
- Diversification: Spreads risk across multiple bonds.
- Tax Benefits: Growth plans defer tax until redemption.
- Disadvantages:
- Subject to credit, interest rate, and liquidity risks.
Types of Debt Funds Based on Maturity:
| Fund Type | Bond Maturity |
|--------------------------|-----------------------|
| Overnight Funds | 1 day |
| Liquid Funds | Up to 91 days |
| Ultra-Short-Term Funds | 3–6 months |
| Short Duration Funds | 1–3 years |
| Medium-Term Funds | 3–4 years |
| Long Duration Funds | Over 7 years |
| Dynamic Bond Funds | Varies dynamically |
Types of Debt Funds Based on Bond Type:
| Fund Type | Bond Type |
|------------------------|-----------------------------------------------|
| Gilt Funds | 80%+ government bonds |
| Corporate Bond Funds | 80%+ high-quality corporate bonds |
| Credit Risk Funds | 65% low-quality bonds (high risk, high return) |
| Floating Rate Funds | 65% floating-rate bonds |
5. Risks in Bonds & Debt Funds:
- Credit Risk:
- Issuer fails to repay. Mitigation: Stick to AAA-rated bonds or gilt funds.
- Interest Rate Risk:
- Bond prices fall when market interest rates rise. Mitigation: Prefer shorter-duration funds.
- Liquidity Risk:
- Inability to sell bonds. Mitigation: Choose funds with large AUMs and liquid bonds.
- Reinvestment Risk:
- Future returns lower as reinvestment happens at reduced rates.
6. When to Choose Bonds vs Debt Mutual Funds:
- Direct Bonds: For investors needing predictable, fixed income.
- Debt Mutual Funds: For diversified exposure and long-term capital growth.
7. How to Choose the Right Debt Fund:
- Match the investment horizon to the fund’s duration.
- Avoid funds with high returns but low credit quality.
- Check the fund’s portfolio composition and credit quality.
- Prefer funds with large AUMs managed by reputed AMCs.
- Avoid funds with exposure to risky corporate bonds unless you understand the risks.
8. Tools & Platforms to Invest:
- Direct Bond Portals: NSE goBID, Zerodha Coin, GoldenPi.
- Debt Mutual Fund Platforms: Groww, ETMoney, Kuvera.
9. Tax Implications:
- Bonds: Coupon income taxed at slab rate.
- Debt Mutual Funds:
- Short-Term (<3 years): Taxed at slab rate.
- Long-Term (3+ years): Taxed at 20% after indexation (better for long-term investors).
10. Quick Tips for Beginners:
- Start with low-risk funds like liquid or overnight funds.
- Diversify across bond types to manage risk.
- Regularly review your portfolio and align it with your goals.
By understanding the basics of bonds and debt mutual funds, you can add stability and predictability to your investment portfolio. Happy investing!
Next: Read 2500+ consumer guides to shopping, electronics, appliances, home services, cars, money and more.
