Short-Term Debt Funds

For those interested to invest in mutual funds, there is a world of options available. Investors who wish to invest in short-term funds have the option of investing in Short-term Debt Funds, also referred to as Income funds. The defining feature of Short-term Debt Funds is that though they are a mutual fund scheme, these funds have a much shorter maturity period or holding period, which is usually below a term of 3 years. Another character feature of these funds is that they normally invest in debt instruments like Government Paper, Corporate Papers and Bank Papers like Certificate of deposit.

However, before making any investment, it is imperative that one gathers all knowledge pertaining to that particular fund. To help you make an informed decision concerning Short-term Debt Funds, here are some of the benefits and risks accompanying Short-term Debt Fund investments.

Benefits of Investing In Short-Term Debt Funds

  • Safe & Stable Returns – Due to the fact that short term debt funds have shorter maturity periods, these funds are comparatively less sensitive to interest rate changes. The debt theory concludes that with the decrease in rates of interest, the market value of debt increases and vice versa. However, changes in market interest rates have a marginal or insignificant effect on short-term debt funds, allowing them to generally perform better in comparison to other funds which are affected by changing interest rates when the market is down or fluctuating. Therefore, short term funds yield stable and safer returns on your investment as they have lower sensitivity to changing interest rates.
  • Flexibility – One of the notable benefits of short term debt funds is that they allow greater flexibility. Investors have the freedom of exiting the fund as and when they are in need of funds in an emergency. Also, unlike other types of mutual funds which may charge a fee for withdrawal, investors do not have to pay any charges if they wish to withdraw their investment from the fund.
  • Tax Benefits – Unlike the interest earned from bank deposits which are taxed, profits earned from short-term debt funds, which have a maturity period of over a year, will attract lower tax, especially for the assesses coming under the high-tax category.

Risks Accompanying Short-Term Debt Funds

Just like any other financial security, short term debt funds are not free from their flaws. Here are some of the risks accompanying these funds.

  • Inflation-Rate Risk – Short term debt funds are an ideal investment only for investors who have short term financial goals stretching up to 2 or 3 years. This is due to the fact that these debt funds are designed to yield returns for short periods. If you are looking to make a long term investment, you can consider investing in equities which balance the rising inflation rate while yielding better returns.
  • Credit Risk – As a practice, funds invest only in instruments which carry a high credit rating and are proven to have a safe track record. However, if in case the asset management company which has issued the debt funds or is managing the fund defaults, then it is entirely upon the investor to challenge the risk resulting thereafter. Hence, investors must also keep this scenario in mind as it pays to be cautious while investing.
  • Interest Rate Risk – Though the impact is marginal, changes in interest rate in the economy do have some effect on short term debt funds. However, given the short maturity period of these funds, these interest rate changes only have a slight or marginal effect on the value of these funds.

Short-term debt funds or Bank FDs?

Short-term debt funds are considered better options in comparison with bank fixed deposits due to the returns they offer, their liquidity and their taxation benefits. The highest rate offered by majority of banks across the country is 7% per annum. When you put them into perspective, the highest rate offered by short-term funds over the last three years is 10.13% per annum. Here are a few reasons why short term debt funds are better options than bank fixed deposits:

  • Rationality of returns
  • The segregation of debt funds takes place as corporate bond funds, ultra short-term funds, liquid funds and floating rate funds based on their holding period. The investment is done in numerous debt instruments as well as fixed income securities such as money market instruments, government securities, treasury bills and corporate bonds. As such, the tax implication associated with these funds will depend upon the kind of fund.

    Debt funds are regarded safer in comparison with equity funds due to the fact that money is invested in fixed income securities and debt instruments which come with a fixed maturity date and offer fixed return. Furthermore, they are not linked strongly to the movement in the stock market.

  • Maintenance of a Healthy Portfolio
  • Asset allocation strategy is significantly determined by short-term debt funds. Considering the fact that equity investments come with a huge short-term risk of capital erosion, investment in equity funds for the purpose of meeting liquidity requirements or financial objectives in the short term is ill-advised.

  • Meeting financial objectives
  • Short-term debt funds are ideal to meet financial targets in the short term (one to three years). Over the years, short term debt funds have built a reputation for offering higher post-tax returns in comparison with other non-equity alternatives. If have financial targets for a very short term (less than one year), the best bet would be investment in ultra-short term funds.

Top Short-Term Debt Funds Based on Returns

Short-term Debt Funds Returns over the past two years Returns over the past three years
Kotak Flexi Debt – Plan A 11.08% 10.13%
ICICI Prudential Short Term Fund 9.74% 9.56%
UTI Banking and PSU Debt Fund 9.74% 9.36%
Franklin India Low Duration Fund 9.66% 9.73%
HDFC Regular Savings Fund 9.45% 9.72%

Disclaimer

Mutual Fund investments will be subject to market risks. Any mutual fund listed in the document does not guarantee fund performance or its underlying creditworthiness. Do read the mutual fund document thoroughly before investing. Specific investment needs and other factors have to be taken into account while designing a mutual fund portfolio.

GST rate of 18% applicable for all financial services effective July 1, 2017.

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