Debt funds offer several advantages but small investors know little about them. Here's how you can benefit from them. We all know that fixed deposits are instruments issued by banks which promise to pay a certain fixed rate of interest on the principal amount for a certain period of time. At the end of this period, the principal along with the accumulated interest (for cumulative schemes) is returned back to the investor. Now, let us briefly understand what a debt fund really is.

What is a debt fund?

A pure debt fund is a mutual fund which would generally invest its corpus in assets generating fixed income. The underlying investments are generally in Central and state government bonds, treasury bills, government securities, high credit rating corporate non-convertible debentures (NCDs) etc. These investments are generally considered very safe as credit rating of the underlying issuing companies/government is very high and a chance of default is negligible. The fee ratios on debt funds are lower, on average, than equity funds because the overall management costs are lower.

Like other mutual funds, one can purchase units of these funds based on daily NAVs (for open-ended funds).

Traditionally, FDs have given returns of 6 -10 per cent (depending upon the tenure of investment) over the past 5 years. Let us see what returns some of the best performing debt funds have given over last 5 years.

Here are five pure debt funds from different fund houses for comparison:

Fund name 1 year 3 years 5 years
Birla Sun Life GSF Long-term 16.09% 10.11% 12.91%
JM G-Sec 13.37% 9.16% 12.54%
Canara Robeco Income-Reg 12.66% 8.91% 12.20%
ICICI Pru Gilt nvestment-Reg 14.20% 9.74% 11.60%
Kotak Gilt Investment-Reg 14.52% 10.46% 11.30%

From the above table, we learn that average return from debt based funds has been around 11.75 per cent pre-tax as compared to 9-10 per cent returns given by FDs in the last 5 years.

Even if we assume that both FDs and debt funds will give same returns, say 9 per cent, in the next 15 years, even then post tax returns for debt funds will be much higher for people falling in higher tax brackets (20 and 30 per cent).

Tax rules have changed

In this year's Budget, the tax rules for debt funds were changed. The minimum tenure for long-term capital gains was extended from one to three years. This means that investors will have to remain invested for at least three years if they want the benefit of lower tax on long-term capital gains.