Best Debt Mutual Funds 2021 – Top 10 Performing Debt Mutual Funds

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Debt mutual funds predominantly invest in fixed-income instruments such as treasury bills, corporate bonds, government securities, and other debt and money market instruments. This article on best debt funds covers the following:

What are Best Debt Mutual Funds?

Debt mutual 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.

Top 10 Best Debt Fund

The table below shows the best-performing debt funds based on the last 5-year returns:

Mutual fund 5 Yr. Returns 3 Yr. Returns Min. Investment Rating

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.

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.

Risks Associated With Debt Funds

Debts funds possess the following risks:

  1. Credit Risk

    This is the possibility of the issuer of the debt security not standing by his obligation of returning the principal at the time of maturity, and regular interest payout.

  2. Interest Rate Risk

    This is the possibility of the movements in the interest rate offered by the underlying securities of the fund plan.

  3. Liquidity Risk

    This is the possibility of the mutual fund house not having sufficient levels of liquidity to cater to the redemption requests.

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 optimising 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.

How to Evaluate Best Debt Mutual Funds?

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

  1. Fund Returns

    It would help if you looked for consistency in returns over long-term, say three, five, or ten years. Choose funds that have outperformed the benchmark and peer funds consistently across different time frames. However, remember to analyse the fund performance, which matches your investment horizon to get results. Note that the past performance is not indicative of future returns.

  2. Fund History

    Choose fund houses that have a strong history of consistent performance in the investment domain. Ensure that they have a consistent track record of at least say five to ten years.

  3. Expense Ratio

    It shows how much of your investment goes towards managing the fund. A lower expense ratio translates into a higher take-home return. If there are two funds with a similar asset allocation and returns, then choose the fund which has a lower expense ratio and has the potential to give you superior performance.

  4. Financial Ratios

    You can use financial ratios such as standard deviation, Sharpe ratio, alpha, and beta, to analyse a fund. A fund having, higher standard deviation, and beta are riskier than a fund with lower beta and standard deviation. Look for funds with a higher Sharpe ratio, which means it gives higher returns on every additional unit of risk being taken.

Advantages of Debt Funds

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

  • Not influenced much by market movements

    The 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 portfolio

    Since 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 investors

    First-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 funds

    Since 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.