When goals are a few months to a few years away, advisors often recommend investors move their funds from equity to debt to insulate the corpus from the stock market’s volatility. Here is a look at some of the popular debt fund categories and how these can be used.
For instant liquidity
If parking money for a few days or weeks, consider overnight and liquid funds. These are the shortest-duration categories in the debt universe, ideal for cash management needs — the kind of money you might otherwise leave idle in a savings account.
Overnight funds invest in securities that mature the next day. They carry virtually no interest rate risk and are among the safest options in the mutual fund space. For anyone who needs a parking spot for a few days, this is the simplest, lowest-risk option.
Liquid funds extend the investment horizon slightly, allowing for investments in instruments that mature in up to 91 days.
‘With bank savings rates languishing around 2.5%, liquid funds can offer anywhere between 5.5% to 6.5% returns,” said Vikram Dalal, managing director at Synergee Capital.
“Liquid funds are a good option to park emergency funds as these offer better returns than bank fixed deposits and can be accessed at a short notice,” pointed out Vishal Dhawan, founder of Plan Ahead Wealth Advisors.
They are ideal for investors who want their emergency money to earn something without being locked up; accessible with a day’s notice. For example, if you submit your redemption request before the 3.00 pm cut-off time, you will get the amount in your account on the next business day. You can redeem up to ₹50,000 per day per investor instantly — the money hits your account the same day.
When goal is a few months away
If you have funds that you won’t need for the next three to twelve months, consider ultra-short duration and money market funds. Think of these as the next step up in the maturity ladder.
You could use these to save for a short-term goal like paying your insurance premium, a minor home renovation, or an upcoming travel plan. They also work well as a bridge investment — when you’re waiting for better opportunities in equity or long-term debt but don’t want your money sitting idle.
Ultra-short funds generally hold instruments with a Macaulay duration (average residual maturity) between three and six months, while money market funds can extend up to one year. Returns typically range between 6.5% and 7.5%, depending on market conditions. These figures are based on the one-year returns these funds have generated as of 23 October 2025. The category average one-year return for ultra short duration funds was 6.9% as of 23 October 2025, according to data from Value Research.
When goal is a few years away
Short-duration funds invest in bonds and other debt instruments with maturities of one to three years, again making them ideal for short-term goals.
These funds aim to balance safety with slightly higher returns. Since they can hold a mix of government securities (G-sec), PSU bonds, and high-quality corporate papers, they offer better yields than liquid or money market funds — typically in the 6.5% to 8.5% range. These figures are based on the one-year returns these funds have given as of 23 October 2025. The category average one-year return for short-duration funds was 7.86%.
“To select the right short-duration funds right now, investors should look for funds that have higher AAA and AA corporate bond holdings rather than gilts or floating rate bonds. Both AAA and AA corporate bonds now offer yields that are attractive relative to the past,” said Aarati Krishnan, head of advisory, primeinvestor.in.
Ensure that the fund’s Macaulay duration (available in factsheet) roughly matches your investment horizon. For example, if you need the money in two years, a fund with a two-year duration is appropriate. If you invest in a longer-duration fund but withdraw earlier, you could see higher volatility in your investments due to mark-to-market volatility. Higher volatility is not ideal when the goal is just a few years away.
The other option is medium duration funds carry Macaulay duration of 3-4 years. “However, be cautious in this category as funds typically take more credit calls in this category,” said Ashish Chadha, a registered investment advisor. “We do not recommend medium-duration funds as a category, though we like specific funds in this space. Medium term funds tend to take on a good bit of credit risk, though their labelling doesn’t indicate this,” Krishnan explained.
What is Macaulay duration
Think of Macaulay duration as the average time it takes for you to get back your money from the bonds the fund holds, through interest payments and maturity.
As a rule of thumb, the longer the duration, the higher the sensitivity to interest rate changes. When interest rates rise, long-duration funds tend to fall more, which can lead to short-term volatility. This makes such funds less suitable for short-term goals.
In contrast, funds with shorter durations are less affected by rate changes because their bonds mature sooner and can be reinvested at new rates more quickly. That’s why investors with shorter time horizons are better off sticking to shorter-duration funds, while those with a longer horizon can take on the higher interest rate risk of long-duration funds for potentially better returns.
“When it comes to debt funds, it is important for investors to match the fund’s duration with their financial goals, rather than chase returns. Debt funds are not meant to chase returns and take undue risks. Hunt for yields or returns could mislead investors to pick funds with higher credit risks,” cautioned Chadha.
Where your goal is beyond three years
Once your goal horizon stretches beyond three years, you can afford a little more duration and volatility — in return for better yields. That’s where corporate bond funds, banking, and PSU debt funds come in.
Corporate bond funds invest predominantly (at least 80%) in AAA-rated instruments. Banking & PSU funds, on the other hand, invest mainly in public sector bank and PSU bonds, which come with the comfort of sovereign backing. These funds’ annual yield right now is between 7.5% and 8.5%, based one-year returns as of 23 October 2025.
The category average one-year return for banking & PSU funds was 7.84%. The category average one-year return for corporate bond funds was 8.12%.
These categories work well for medium-term goals. They also serve as a core debt allocation in a conservative portfolio, balancing risk and return more effectively than shorter-duration funds.
Here too, investors must watch out for funds investing in low-rated credit papers to chase returns.
Patient money
Long-duration or G-sec funds invest in government securities with maturities of 10 years or more. These bonds are highly sensitive to interest rate movements — meaning even a small change in rates can cause large swings in their prices.
Here’s why: when interest rates rise, the market value of existing bonds (which pay lower fixed interest) falls, because new bonds are issued at higher yields. Since long-duration funds hold bonds that mature far in the future, their prices react much more sharply to these changes.
That’s what makes them risky in the short run. If you invest just before a period of rising rates, your fund value could temporarily dip, even if the bonds themselves are perfectly safe in terms of credit quality (because they’re government securities).
Over long periods — say seven years or more — these ups and downs tend to even out. That’s why such funds are best suited for investors who can stay invested through an entire interest rate cycle, ideally entering when rates are high and poised to fall.
In that phase, long-duration funds can deliver strong capital gains, making them useful for long-term goals like retirement or a child’s education. However, this is a tactical call and should only be used by savvy investors who can handle the volatility associated with interest rate cycles. It is also difficult to predict how the interest cycle would behave over a long period of time.
“Investing in G-sec funds is like rearing a child, very painful in the growing-up years from time to time, but very rewarding if you hold them to their duration. It can potentially also add enormous value,” Chadha said. The RIA has ₹85 crore of client money invested in G-sec funds, built over the last 17 years as part of their overall asset allocation.
Takeaway
Debt funds offer another advantage over traditional banking instruments — you are not taxed on interest each year. Interest received by the debt fund is added to the fund’s NAV (net asset value). So, gains are taxed only when you redeem your units, and at your income tax slab rate (since indexation benefits on long-term holdings were removed after April 2023). This deferral allows your returns to compound more efficiently over time.
While debt funds are recommended for very short to medium-term goals, understanding the time horizon of your goals and investing in debt funds that match this duration is crucial to maximize the benefits of debt funds. Avoid funds with high credit risks, as these funds also face default risk on their investments.