Short Duration Funds

What Are Short Term Funds?

As the name suggests, short term mutual funds involve putting the funds in short term money market investments of high-quality and low risk. They are open ended funds with a maturity time range of anything between 15 to 91 days, depending upon the maturity period of the underlying instruments.

Short term mutual funds have a moderately low interest rate risk and are a good option to park your surplus funds for short durations like a month or two. They are best for those looking for risk asset options as they are mainly debt-oriented mutual funds that are high-yielding but of low risk.

Who Should Invest in Short Term Funds?

Short term mutual funds are debt-oriented funds that restrict their portfolio investment to instruments that yield returns based on income derived from interest and have short-term maturities. Hence, these funds are best suited for those:

  • Having an investment horizon of shorter than three months- These funds provide a better option to invest surplus funds into, as they provide higher returns than bank deposits in savings accounts without compromising on the liquidity factor.
  • Investors are looking for risk-aversion- Since these funds attract low risk due to their shortened maturity of the underlying securities, it is best for investors who want their money to be safe yet earn a good percentage of returns on them. These funds have recorded returns to the tune of 6%-8% as per records.

However, before investing in short term funds, investors should keep the following points in mind:

  • Ensure that the duration of the fund matches your investment tenure
  • Check the credibility and ratings of the underlying investment securities in the scheme portfolio
  • With regard to credit risk management, check the track record of the fund manager and the fund house

Some of the best short term mutual funds include Edelweiss Banking and PSU debt fund- Direct Plan-Growth, Edelweiss Banking, PSU debt fund, HDFC Corporate Bond Fund- Direct Plan-Growth, HDFC Medium Term Debt Fund-Direct Plan Growth, and so on.

Features of Short Term Funds

Short term funds are a better investment option than bank deposits like savings accounts or fixed deposits. Depending upon the assets in your portfolio, these funds can fetch returns at around 8-9 per cent annually. Apart from this, some of the other attractive features are:

  • Returns- These funds offer better returns in comparison to bank deposits like fixed deposits and savings funds. Also, with the added tax benefits attached to these funds, the overall returns on short term mutual funds work out to be higher than most post-tax returns earned from other investment schemes.
  • Investment horizons- Since these funds aim to provide lower interest rate risk and offer better tax-adjusted returns, these funds do not invest in instruments that have long-term maturity. They generally invest in money market instruments like commercial papers, bonds etc.
  • Dividend payout- These funds have an option of dividend payouts, where investors can get monthly or fortnightly returns on their investments.

Taxability of Short Term Funds

Short term funds are best suited for investors who prioritize capital preservation and earn from interest accrual in the debt portfolio.

Regarding the taxation policy, as per the Budget 2020 amendments, the dividends earned on mutual funds is added to the total income and taxed as per their income tax slab. These debt funds are computed in the following manner:

  • If the holding period of the debt investment is less than 36 months, it is taxed under the individual’s income tax slab and is classified as a short-term investment.
  • If the holding period of the debt investment is more than 36 months, it is a long term investment with a tax of 20% levied with indexation benefits.
  • Short term mutual funds can opt for a growth option, where the tax treatment is identical to a bank fixed deposit. Or dividend options where the income from the investment is exempt from tax.

Risks Involved With Short Term Funds

Just like other debt funds, short term funds carry the same risk component as they represent a class of debt funds. Hence, even though these investments have a short validity or maturity date, they come attached with certain flaws and risks. They are:

  • Liquidity risk- There is always an uncertainty of the fund manager not being able to sell the underlying instruments of your short-term funds without incurring a loss, which raises a question on its liquidity factor.
  • Rick of rising inflation- Short term funds are best for those with a short term financial goal in mind. However, people who want the benefits of rising inflation and are yet to keep their investments to yield good returns under such scenarios should opt for long term equity funds.
  • Credit risk- There is always a possibility that the issuers of the underlying securities of short term funds may deviate from their promise of paying regular interest and the principal amount on maturity.
  • Risk of changing interest rates- Various economic and geopolitical factors may affect the probability of the rate of interest fluctuation, even with the best short term funds, as otherwise committed by the issuers of the underlying instruments.

Advantages of Short-Term Funds

Short term or short duration fund, is one of the safest and most advantageous plans to invest in, the primary reason being that they can be encashed within a week of their approval. This means that if you are in a dire need of immediate cash, you can avail of your spare funds, invested in short term funds, without having to go hither-thither, struggling for it.

There are several other benefits that investors can avail of by investing in some of the best short term funds. They are:

  • Short term mutual bonds have shorter maturity, and hence they normally offer safe and stable returns.
  • Short term funds are not market sensitive. Hence, they offer better returns than other funds that are affected by fluctuation in the market.
  • These funds have high liquidity, which gives the investors the leverage to withdraw their funds in an emergency.
  • The investors get exposed to various portfolios as their funds get diversified over various debt and money market securities.
  • There is minimal to no exit load for investors of short-term funds as these funds typically do not charge any fee for withdrawal.
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