Best Debt Mutual Funds in India for 2025 | Top Funds by Tenure & Tax Benefits

Best debt funds vary according to the tenor of investment of the investor. Investors need to be clear on their time horizon of investment when selecting the best Debt fund for their investment and also factor in the interest rate scenario.

For investors with a very short holding period, say for a couple of days to a month, Liquid Funds and ultra-short term funds may be relevant. When the time horizon is one to two years then short-term funds may be the desired vehicle. For longer tenors, for more than 3 years, long-term debt funds are the most preferred instruments by investors, especially during falling interest rates. Above all, debt funds have proved to be less risky than equities when looking for short-term investments, however, the volatility of long-term income funds may match that of equities.

As debt funds invest in fixed income instruments like government securities, treasury bills, corporate Bonds, etc., they have the capacity of generating consistent and regular returns over time. However, there are many qualitative and quantitative factors that one needs to understand before selecting the best debt funds to invest, viz - AUM, Average Maturity, Taxation, the credit quality of the portfolio, etc. Below we have listed the top 5 best debt funds to invest across the various categories of debt funds - Best Liquid Funds, best ultra short-term funds, best short-term funds, best long-term funds and best Gilt Funds to invest in 2025 - 2026.

Quick Summary

✅ Best for short-term: Liquid, Ultra-Short, and Money market funds

✅ Best for 1–2 years: Short-term bond funds

✅ Best for 3+ years: Gilt funds, Corporate bond funds, Dynamic Bond Funds

✅ Risks: Credit risk, Interest rate risk

✅ Tax: 20% with indexation if held for more than 3 years

Why To Invest in Debt Mutual Funds?

• Debt funds are considered to be an ideal investment for generating regular income. For example, choosing dividend payout can be an option for regular income.

• In debt funds, investors can withdraw required money from the investment at any point in time and can let the remaining money stay invested.

• Since debt funds largely invest in government securities, corporate debt and other securities like treasury bills, etc., they are not affected by equity market volatility.

• If an investor is planning to achieve short-term Financial goals or invest for short periods then debt funds can be a good option. Liquid funds, ultra short-term funds, and short-term income funds may be the desired options.

• In debt funds, investors can generate fixed income every month by starting a Systematic Withdrawal Plan (SWP is a reverse of SIP / STP) to withdraw a fixed amount on a monthly basis. Also, you can change the amount of the SWP when required.

Key Benefits of Debt Funds in 2025

• Safer than equities in volatile markets
• Offer liquidity and low lock-in
• Tax-efficient with indexation benefit after 3 years
• Flexible options for all durations and risk profiles
• Suitable for conservative and semi-aggressive investors alike

Risks in Debt Mutual Funds

While Investing in debt funds, investors should be cautious about two major risks associated with them - credit risk and interest rate risk.

Credit Risk

A credit risk arises when a company that has issued the debt instruments does not make regular payments. In such cases, it has a major impact on the fund, depending on how much portion the fund has in the portfolio. Hence, it is suggested to be in debt instruments with a rating higher credit rating. An AAA rating is considered to be the highest quality with little or negligible payment default risk.

Interest Risks

The interest rate risk refers to a change in the bond price due to the change in the prevailing interest rate. When the interest rate rises in the economy the bond prices fall down and vice versa. The higher the maturity of the funds’ portfolio, the more prone it is to the interest rate risk. So in a rising interest rate scenario, it is advisable to go for lower maturity debt funds. And the reverse in a falling interest rate scenario.

Debt Mutual Fund Taxation

Tax implication on debt funds is computed in the following manner-

a. Short Term Capital Gains

If the holding period of a debt investment is less than 36 months, then it is classified as a short-term investment and these are taxed as per individual's tax slab.

b. Long Term Capital Gains

If the holding period of debt investment is more than 36 months, then it is classified as a long-term investment and is taxed at 20% with an indexation benefit.

📌 Note: Indexation helps adjust the purchase price with Inflation, effectively reducing your tax liability.

Best Debt Mutual Funds in India for Investments FY 25 - 26

Top 5 Liquid Mutual Funds

Top Liquid funds with AUM/Net Assets > 10,000 Crore.

Top 5 Ultra Short Term Bond Mutual Funds

Top Ultra Short Bond funds with AUM/Net Assets > 1,000 Crore.

Top and Best Floating Rate Mutual Funds

Top 5 Best Money Market Mutual Funds

Top 5 Short Term Bond Mutual Funds

Top 5 Medium to Long Term Bond Mutual Funds

Top Medium to Long Term Bond funds with AUM/Net Assets > 500 Crore.

Top 5 Banking and PSU Debt Mutual Funds

Top 5 Credit Risk Mutual Funds

Top Credit Risk funds with AUM/Net Assets > 500 Crore.

Top 5 Dynamic Bond Mutual Funds

Top Dynamic Bond funds with AUM/Net Assets > 500 Crore.

Top 5 Corporate Bond Mutual Funds

Top Corporate Bond funds with AUM/Net Assets > 500 Crore.

Top 5 Gilt Mutual Funds

Top GILT funds with AUM/Net Assets > 500 Crore.

How to Evaluate Best Debt Mutual Funds

In order to select the best debt funds you wish to invest in, it is necessary to consider some of the important parameters such as average maturity, credit quality, AUM, expense ratio, tax implication., etc. Let's have an in-depth look-

1. Average Maturity/Duration

Average maturity is an essential parameter in debt funds that is sometimes overlooked by investors, who tend to invest for a long period without considering the risks involved. Investors need to decide their debt fund investment based on its maturity period, Matching the time period of investment with the maturity period of the debt fund is a good way to ensure you don't end up taking unnecessary risk. Thus, it is advisable to know the average maturity of a debt fund, before investing, in order to aim for optimum risk returns in debt funds. Looking at the average maturity (duration is a similar factor) is important, for example, a liquid fund may have an average maturity of a couple of days to maybe a month, this would mean it is a great option for an investor who is looking to invest money for a couple of days. Similarly, if you are looking at the time frame of one-year Investment plan then, a short-term debt fund can be ideal.

2. Interest Rate Scenario

Understanding the market environment is very important in debt funds which are affected by interest rates and its fluctuations. When the interest rate rises in the economy, the bond price falls and vice-versa. Also, during the time when the interest rates rise, new bonds are issued in the market with a higher yield than the older bonds, making those older bonds of lower value. Therefore, investors are more attracted towards newer bonds in the market and also a re-pricing of older bonds takes place. In case a debt fund is having an exposure to such "older bonds" then when the interest rates rise, the NAV of the debt fund would be impacted negatively. Furthermore, as debt funds are exposed to interest rate fluctuations, it disturbs the prices of the underlying bonds in the fund portfolio. For instance, long-term debt funds are at a higher risk during times of rising interest rates. During this time making a short-term investment plan will lower your interest rate risks.

If one has good knowledge of interest rates and can monitor the same, one can even take advantage of this. In a falling interest rate market, long-term debt funds would be a good choice. However, during the times of rising interest rates then it would be wise to be in funds with shorter average maturities like short-term funds, Ultra Short Term fund or even liquid funds.

3. Current Yield or Portfolio Yield

The yield is a measure of the interest income generated by the bonds in the portfolio. Funds that invest in debt or bonds that have a higher coupon rate (or yield) would have a higher overall portfolio yield. The yield to maturity(ytm) of a debt mutual fund indicates the running yield of the fund. When comparing debt funds on the basis of YTM, one should also look at that fact that how is the extra yield being generated. Is this at the cost of as lower portfolio quality? Investing in not so good quality instruments has its own issues. You don't want to end up investing in a debt fund which has such bonds or securities that may default later on. So, always look at the portfolio yield and balance it off with the credit quality.

4. Credit Quality of Portfolio

In order to invest in best debt funds, checking the credit quality of the bonds and debt securities is an essential parameter. Bonds are assigned a credit rating by various agencies based on their ability to pay the money back. A bond with AAA rating is considered to be the best credit rating and also implies a safe and secure investment. If one truly wants safety and considers this as the paramount parameter in selecting the best debt fund, then getting into a fund with very high-quality debt instruments (AAA or AA+) may be the desired option.

5. Assets Under Management (AUM)

This is the foremost parameter to consider while choosing the best debt funds. AUM is the total amount invested in a particular scheme by all investors. Since, most Mutual Funds’ total AUM is invested in debt funds, investors need to select scheme assets that have a considerable AUM. Being in a fund which has a large exposure to corporates may be risky, since their withdrawals may be large which may affect the overall fund performance.

6. Expense Ratio

An important factor to be considered in debt funds is its expense ratio. A higher expense ratio creates a larger impact on the funds’ performance. For example, liquid funds have the lowest expense ratios which are up to 50 bps (BPS is a unit to measure interest rates wherein one bps is equal to 1/100th of 1%) whereas, other debt funds could charge up to 150 bps. So to make a choice between one debt mutual fund, it is important to consider the management fee or the fund running expense.

7. Taxation Impacts

Debt funds offer the benefit of long-term capital gains (more than 3 years) with indexation benefits. And the short term capital gains (less than 3 years) is taxed at 30%.

Things to consider as an investor

1. Fund Objectives

Debt Fund aims to earn optimal returns by maintaining a diversified portfolio of various types of securities. You can expect them to perform in a predictable manner. It is because of this reason, that debt funds are popular among conservative investors.

2. Fund Types

Debt funds are further divided into various categories like liquid funds, Monthly Income Plan (MIP), fixed maturity plans (FMP), dynamic bond funds, income funds, credit opportunities funds, GILT funds, short-term funds and ultra short-term funds.

3. Risks

Debt funds are basically exposed to interest rate risk, credit risk, and liquidity risk. The fund value may fluctuate due to the overall interest rate movements. There’s a risk of default in the payment of interest and principal by the issuer. Liquidity risk happens when the fund manager is unable to sell the underlying security due to lack of demand.

4. Cost

Debt funds charge an expense ratio to manage your money. Till now SEBI had mandated the upper limit of expense ratio to be 2.25% (Might change time to time with regulations.).

5. Investment Horizon

An investment of 3 months to 1 year would be ideal for liquid funds. If you have a longer horizon of say 2 to 3 years, you may go for short-term bond funds.

6. Financial Goals

Debt funds can be used to achieve a variety of goals like earning additional income or for purpose of liquidity.

How to Invest in Best Debt Funds Online?

1. Open Free Investment Account for Lifetime at Fincash.com.

2. Complete your Registration and KYC Process

3. Upload Documents (PAN, Aadhaar, etc.). And, You are Ready to Invest!

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Conclusion

Debt funds are one of the best ways to invest your money and generate income on a regular basis by choosing the relevant product matching your risk profile. So, investors looking to generate steady income or take advantage of the debt markets, can consider the above best debt funds for 2025 - 2026 and start investing!_