Short-term funds are mutual funds that invest in debt-based instruments in the short-term, between 1 to 3 years They invest money in low-risk debt instruments such as government bonds, treasury bonds, corporate bonds, etc. Short-term debt funds are highly suited for individuals who cannot bear much risk and are looking to invest for less than 3 years.
Short-term investing cannot be applied to equity. One must invest in equity only if one wants to stay invested for a long time since the risk of losing value is very high in the short-run. For this reason, most of the short-term funds invest in debentures and other related bonds. These funds offer a decent rate of return and are most suitable for short-term investing.
Returns and risks involved:
The short-term funds primarily invest in the debt instruments and fixed income securities like bonds, government securities, etc. To maximize the returns, these funds invest in higher maturity instruments in one period and then switch to a low maturity instrument. They invest in long term instruments if the interest rates are falling which increase the bond prices. Most of these funds invest in high-quality and AAA rated securities which make them a low risk investment
Should you choose short-term funds over FDs?
Short-term Funds have historically delivered better returns than fixed deposits. A downward trend in the market is the only situation where FD’s may outperform short-term funds. Short-term funds are suited for investors with a low-to-moderate risk appetite, while fixed deposits are practically the most secure investment. The former manages to beat inflation through the power of compounding, while the latter usually struggles.
Short-term funds provide better returns than FDs. Nowadays, 7% p.a. is the highest interest rates offered by the banks on FDs whereas some of the best performing short-term debt funds have been able to achieve an annualized return of 10.13% in the last three years.
Even though, the FDs are highly liquid and can be redeemed quickly but there is penalty as well as lower interest rate is paid. For example, if you have an FD for two years at 7% and you decide to redeem the money in six months, then you will be paid the prevailing interest rate for a six-month FD which can be say 5% and in addition you will be charged a penalty of 1%. Whereas, in case of the short-term debt funds, there is an exit load of 0.5% to 1% on most occasions on early redemption.
Also, the tax liability on debt funds arises at the time of sale of the fund and hence the tax payment can be deferred until the gains are realised. So, if you hold to your investments for 10 years and sell on the 11th year, you can defer tax payment on the gains through the holding period.
The Bottom Line:
Short-term funds are considered the best option for the conservative investor with a low-risk appetite. These investments manage to beat inflation and are tax efficient as well.
Connect with a WealthApp Financial Advisor to know more about short-term funds.