What Are Short-Term Mutual Funds?
Mutual funds that invest in debt instruments with maturities ranging up to three years are considered short-term mutual funds. Historically, these funds have shown larger returns than savings and fixed deposit rates.
The benefits of investing in short-term funds
- Ideal for the money that you won’t require for at least a year to a year and a half.
- These products can generate higher returns than bank fixed deposits while minimizing risk.
- If kept for three years or more, they offer a better tax advantage than fixed deposits.
According to SEBI’s regulations, there is nothing officially referred to as short-term mutual funds, which essentially indicates that they don’t exist! Therefore, properly speaking, short-term mutual funds are investments made for a small period of fewer than 5 years rather than a category. Therefore, in the article, we will cover short-term mutual funds such as liquid funds, ultra-short duration funds, low duration funds, short-duration funds, money market funds, etc.
Categorization of Short Term Mutual Funds:
- Overnight Funds:
These funds invest in debt instruments having a maturity of 1 day.
- Money Market Funds:
These funds invest in money market instruments having maturity up to 1 Year.
- Liquid funds:
These are debt funds that invest in short-term assets like commercial paper, government securities, treasury bills, etc. Liquid funds are only permitted to invest in debt and money market instruments with maturities of up to 91 days.
The market value of the securities held by a liquid fund determines the fund’s return. The returns of liquid funds are, however, often more consistent when compared to other debt funds because the prices of short-term securities do not fluctuate as much as long-term bonds.
- Ultra Short Duration Funds:
These are debt funds that invest in debt and money market assets such that the Macaulay duration of the portfolio ranges from three to six months. Historically, compared to funds such as long-duration funds, corporate bond funds, etc, these funds are less volatile and attempt to create more predictable income, making them suited for short-term investments.
- Low duration Funds:
These debt funds are those that invest in short-term debt instruments, with a portfolio duration of between six and twelve months. Low-duration funds contain assets with a longer-term and/or lower credit quality than overnight or liquid funds; as a result, they have a considerably larger interest rate risk and credit risk.
- Short duration funds:
These are debt funds that hold a portfolio of debt and money market assets with a duration between one and three years. These funds are subject to moderately low-interest rate risk. The credit risk of short-term funds might vary based on the credit quality of the underlying securities.
A Brief Introduction of Debt Funds
Mutual funds that invest in fixed-income instruments such as bonds and treasury bills are known as debt funds. Debt funds invest in the gilt fund, monthly income plans (MIPs), short-term plans (STPs), liquid funds, and fixed maturity plans (FMPs).
In addition to these categories, debt funds also invest in short-term, medium-term, and long-term bonds. Individuals who are unwilling to invest in a highly volatile equity market prefer debt funds. Historically compared to equity funds, debt funds provide a regular but low income. It is also relatively more stable.
Short-term mutual funds can include certain types of debt funds. Depending on the amount of money you have available, you could invest in this mutual fund for a month or a few years. For short-term funds, the Macaulay (average) duration (explained below) typically varies up to three years.
What is Macaulay’s duration?
Macaulay Duration is the length of time taken by the investor to recover his invested money in the bond through coupons and principal repayment. This length of time is the weighted average of the period the investor should remain invested in the security to have the present value of the cash flows from the investment match the amount paid for the bond.
Best Short Term Mutual Investments 2022
Best Short Duration Fund (as per 3-Year return)
| Scheme | 3 Year Return (CAGR) | AUM (Cr) |
| UTI Short Term Income Fund |
8.62% |
2,349.23 |
| IDBI Short Term Bond |
7.37% |
29.91 |
| Sundaram Short Duration Fund |
7.04% |
215.07 |
| PGIM India Short Duration Fund |
7.58% |
26.50 |
| ICICI Prudential Short Term Fund |
7.39% |
15,540.67 |
| Aditya Birla Sun Life Short Term Fund |
7.24% |
4,648.37 |
| Nippon India Short-Term Fund |
7.11% |
7,272.52 |
| HDFC Short Term Debt Fund |
7.07% |
13,842.72 |
| Axis Short Term Debt Fund |
7.06% |
6,538.21 |
| Kotak Bond Short-Term Fund |
6.71% |
12,154.55 |
Source: AMFI (data collected as of 11/07/22)
Best Liquid Funds (as per 1-Year returns)
| Scheme | 1-Year Return (CAGR) | AUM (Cr) |
| White Oak Capital Liquid Fund |
3.27% |
60.87 |
| Indiabulls Liquid |
3.41% |
229.04 |
| Motilal Oswal Liquid Fund |
3.45% |
562.47 |
| IIFL Liquid Fund |
3.51% |
994.6 |
| Parag Parikh Liquid Fund |
3.52% |
1,391.68 |
Source: AMFI (data collected as on 11/07/22)
Best Ultra Short Duration Fund (as per 1-Year return)
| Scheme | 6-Month Return (CAGR) | AUM (Cr.) |
| Franklin India Ultra Short Bond Fund |
11.27% |
NA |
|
6.71% |
2,042 |
|
| Nippon India Ultra Short Duration Fund |
4.77% |
3,880.44 |
| IDBI Ultra Short Term |
4.32% |
237.70 |
| ICICI Prudential Ultra Short-Term Fund |
4.27% |
10,695.92 |
Source: AMFI (data collected as on 11/07/22)
Best Low Duration Fund (as per 1-Year return)
| Scheme | 1-Year Return (CAGR) | AUM(Cr) |
| Franklin India Low Duration Fund |
17.83% |
NA |
| Sundaram Low Duration Fund |
11.58% |
471.70 |
| UTI Treasury Advantage Fund |
8.95% |
2743.02 |
| Nippon India Low Duration Fund |
4.21% |
7,738.81 |
| Aditya Birla Sun Life Low Duration |
4.17% |
11,930.55 |
Source: AMFI (data collected as on 11/07/22)
Best Money Market Fund (as per 1-year return)
| Scheme | 1-Year Return | AUM(Cr) |
| Tata Money Market Fund |
4.06% |
8,376.85 |
| Nippon India Money Market Fund |
4.05% |
9,817.97 |
| PGIM India Money Market Fund |
4.02% |
54.31 |
| Kotak Money Market Fund |
3.98% |
15,398.57 |
| UTI Money Market Fund |
3.97% |
8657.52 |
Source: AMFI (data collected as on 11/07/22)
Best Overnight Fund (as per 1-year return)
| Scheme | 1-Year Return | AUM (Cr) |
| Bank of India Overnight fund |
3.66% |
29.73 |
| HSBC Overnight Fund |
3.59% |
715.86 |
| Mahindra Manulife Overnight Fund |
3.59% |
209.92 |
| Mirae Asset Overnight Fund |
3.58% |
538.50 |
| Axis Overnight Fund |
3.57% |
11,628.13 |
Source: AMFI (data collected as of 11/07/22)
What are the Benefits of Investing in Best Short-Term Mutual Funds?
- Liquidity
You can count on adequate liquidity with these funds. After investing, you may withdraw your money at any moment. However, when doing so, pay attention to exit loads.
- Short-Term Investment Objective
Short-term mutual funds are available for investment at any time, which is particularly helpful for achieving short-term financial objectives. These funds can greatly aid you in achieving your short-term investment goals if you have an investment horizon of up to one to three years.
- Stability
Nearly all short-term funds are debt funds that are categorized based on holding length. Since they invest in fixed income securities like treasury bills, corporate bonds, government securities, and money market instruments, debt funds are more secure than equity funds (and more).
- Diversification
Short-term debt funds contribute to portfolio diversification and stability. In contrast to equity investments, which require a longer-term, short-duration funds can not only mitigate risk but also provide good returns for investments held for less than three years.
- Resilience
Historically, as compared to equity funds, top short-term funds are relatively resilient to fluctuations in the financial markets.
Risks Possessed by Short-Term Funds
When compared to equity funds, short-duration mutual funds are unquestionably less volatile, but they still have their own risks and limitations. Here are some potential risks associated with buying short-term mutual funds:
- Inflation
Inflation could have a detrimental effect on short-term investments by bringing up interest rates exponentially and lowering returns or driving down the value of your investment.
- Credit Risk
Any short-term mutual fund comes with a variety of credit risks. Ratings are given to short-term debt funds by credit rating agencies like CRISIL, which reflect the credit quality and risk exposure of the funds. As a result, investing in these mutual funds exposes you to credit risk should the company experience a payment default.
- Rate of Interest
The prevailing interest rate determines the net asset value and returns of a debt mutual fund. A high-interest rate will reduce your profits, and vice versa. Similarly, a higher interest rate results in a lower mutual fund price, and vice versa. Consequently, a fluctuating interest rate could have an impact on your investment.
- Low maturity period risk
To assess the interest rate risk associated with the short-term debt mutual fund, you must examine its average maturity value. Thus, a low maturity term will have a minimal effect on the effect of a shift in interest rates.
Factors to Consider Before Investing in Short-Term Mutual Funds
- Risk:
Short-duration funds are the entry point for investors who are willing to accept some interest rate risk for higher returns. In general, these funds typically offer stable short-term returns.
Nonetheless, if there are unanticipated fluctuations in interest rates, the value of a fund may be quite volatile. For instance, suppose that if a rate cut is widely anticipated.
Fund managers will raise their holdings of long-term debt if market interest rates begin to fall. Now, if the RBI unexpectedly pauses its rate action (neither raises nor lowers rates), market yields will correct by increasing.
This will result in a drop in the fund’s value, which will not be reversed until interest rates decline again and/or (ii) the fund’s accumulated interest income restores the fund’s value.
Therefore, investors must be aware that short-duration funds endure occasional bouts of volatility, and this must be taken into account when making an investment decision.
Investing in short-term mutual funds is desirable if you seek a low-to average-yielding investment with low risk. Since fund managers typically choose investments with strong credit ratings, this type of investing entails minimal risk.
- Credit Risk:
Some short-duration funds may carry a higher credit risk than others, exposing them to the risk of default and possible value loss. During the recent NBFC crisis, there were instances of value degradation among debt funds caused by bond issuer defaults. Results on short-term funds are not guaranteed, and previous performance is no guarantee of future returns.
- Expense Ratio:
Since these funds are volatile and require active management, there may be a cost associated with their management. This fee, levied by fund managers as a proportion of your investment’s returns and gains, is known as the expense ratio. Knowing the expense ratio can help you comprehend the additional fees you will incur.
- Taxation:
Short-term mutual funds are significantly more tax-efficient than other types of investments such as fixed deposits. If the duration of your investment is less than three years, capital gains will be added to your income and taxed at the applicable income tax slab rate. Long-term capital gains (investment holding time of three years or more) will be taxed at 20% after indexation benefits are taken into account.
- Exit Load:
You can be charged an exit load if you decide to redeem your money before the period of a few days or months (depending on your investment) has passed. Check out the exit load you can be charged before selling your investment.
FAQs
-
What is the best short-term investment?
As per the information given in the article, there are various types of short-term investment funds with certain strengths and weaknesses. Investors may prudently pick any of them as per their risk appetite and investment objectives.
-
Are mutual funds good for the short term?
Investors with investment horizons of up to three years can choose short-term mutual funds. These funds are a better place to save your extra money than traditional savings institutions.
Historically, short-term funds have shown the potential to yield higher rates of return than bank deposits and also offer much-needed liquidity.
Since the risk posed by these funds is on the lower side due to the shorter maturity period of the underlying securities, risk-averse investors may want to think about investing in them. These funds have historically generated returns between 6 to 8 per cent, as observed in the above-mentioned table.
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Can I invest in mutual funds for 6 months?
Yes, there are 4 categories of short-term funds as per the tenure of investment in debt or money market instruments. You can invest in any of them as per your investment objectives.
- Liquid Funds: These funds have a portfolio maturity of less than 91 days.
- Ultra Short-Term Bond Funds: These funds have a portfolio maturity of 3 months to 6 months.
- Low Duration Funds: Portfolio maturity ranges from 6 months to 1 year
- Short Duration Funds: Portfolio maturity ranges from one to three years
-
Who Should Invest in Short-Term Mutual Funds?
- Investors with modest risk tolerance and a short-term investment horizon
- Investors should make sure that the length of their investments is equal to or greater than the portfolio’s average maturity.
- In a macro environment of rising interest rates, investors with time horizons of up to 3 years can profit from these funds.
- Investors who seek to take advantage of the long-term capital gains tax indexation for investments lasting more than three years.
-
What is the return potential of the best short-duration funds?
As per the above-mentioned historical return, short-duration funds have provided an average return between 7% to 8% CAGR.
-
Which type of mutual fund is best for the short term?
As mentioned above, all types of short-term mutual funds have different unique characteristics as per their risk profile, volatility, liquidity, investment horizon, etc. For example, liquid funds are one of the safest among them as they invest in low-duration debt (91-day maturity) and money market instruments, they are also least affected by market volatility and interest rate changes.
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