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Before investing in mutual funds, assessing your risk appetite and investment goals is crucial. This helps you zero in on the best scheme that helps you achieve your planned objectives effortlessly. 

 

If you plan to invest in open-ended funds with a short maturity timeline, you may opt for short-term mutual funds. Read on to know the advantages of short-term mutual funds, how these funds work, factors to consider and more.

What are Short Term Mutual Funds?

A short-term mutual fund is a debt fund with a short investment horizon ranging from 1 to 3 years. The corpus is usually invested in companies having a profitable business and high creditworthiness.

 

Remember that investing in short duration funds can expose you to credit risk, inflation risk and liquidity risk. Hence, it is crucial to consider these factors before you invest in these mutual funds.

How Do Short Duration Funds Work?

When you opt for short-term funds, your corpus is invested across a mix of instruments, such as treasury bills, corporate bonds, etc. The prime goal of investing in these funds is to generate a regular income coupled with a low-risk profile.

 

As these funds have a lower maturity timeline, they are less sensitive to interest rate changes in the market. This is precisely why such funds are considered safer investment alternatives than long duration ones.

Pros of Short Duration Funds

Now that you know the short-term funding meaning, here are some advantages associated with investing in the fund.

  • Short Investment Horizon

A significant advantage of short-term mutual funds that boost their popularity is their short investment horizon ranging between 1 and 3 years. Investing in this type of mutual fund allows you to enjoy great returns and various other benefits in a shorter timeline. 

 

If you are a conservative investor, this investment option is the best for you. Also, the year-over-year returns continue to rise, contributing to the overall growth of this investment avenue.

  • Provides Stable Returns

Another great advantage that comes with investing in a short-term mutual fund is that you have the possibility of getting stable returns. This is because these are debt funds. 

 

Any movement in the capital market does not significantly impact debt funds. These funds come with a predetermined rate of return and maturity, therefore offering predictable returns. 

  • Diversifies the Portfolio

Short-term mutual funds are typically considered low-risk investments since they invest in securities with a strong track record and credibility. These securities include money market instruments, corporate bonds, treasury bills, government securities, etc. 

 

When you invest in such securities, which may not be largely affected by market scenarios, you can adequately balance your portfolio. 

  • Helps Meet Financial Goals

By investing in a short-term mutual fund strategically, you can save for your financial goals. Within a short investment period, these funds provide great returns compared to parking your funds in a fixed deposit or savings account. 

 

You can invest in debt funds to meet both your short and long-term financial goals.

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Cons of Short Duration Funds

While short term funds offer numerous benefits, here are some cons of investing in these funds.

  • Increased risk of inflation, liquidity and credit parameters

  • Expected returns lower than equity mutual funds

  • Existing interest rates affect the prevailing NAV or Net Asset Value of the fund

  • If the interest rate is higher, your fund value appreciates and vice versa

Things to Consider When Investing in Short Duration Funds

Investing is an important decision that requires caution and discipline. Here are some key points to consider when investing in short-term mutual funds.

  • Personal Investment Goals

Your investment objectives, risk tolerance, and preference of investment horizon are essential in choosing the right plan. 

 

Always consider your investment objectives before finalising any mutual fund scheme since they need to align with your investment returns. This is an ideal option if you are a conservative investor willing to invest your corpus for at least 1-3 years. 

  • Associated Returns and Risks

When investing, monitor the fund’s portfolio and performance to see if it aligns with your expected returns. 

 

Despite the associated risk being lower, pay attention to the interest rate and credit risk. These risks can cause a decline in the underlying assets' values, impacting the fund's NAV.

  • Investment Charges

Like every investment, short-term mutual funds also come with some charges. Consider the expense ratio of the fund before finalising a scheme. Always look for a fund with a lower expense ratio, as it can help you earn better returns due to lower mutual fund charges.

  • Taxation 

You can earn dividends and capital gains from short-term mutual funds. According to the Budget 2020 amendments, dividends by all mutual funds get added to your income. They get taxed according to your income tax slab. The tax implications are calculated based on the holding period. 

 

The investment is considered short-term capital gains (STCG) if you hold the units for 3 years and get taxed as per the income tax slab you fall under. If you hold them for 3 years or more, they are treated as long-term capital gains (LTCG) and taxed at 20% after indexation. Without the benefit of indexation, LTCG is charged at 10%.

Who Should Consider Investing in Short Term Funds

Short duration mutual funds are ideal if you have a lower risk tolerance and want to invest for a shorter investment period of 1-3 years. These funds carry a lower risk level since the underlying securities' maturity period is also lower. 

 

Also, this investment provides a better interest rate than a savings account and offers adequate liquidity. As you can see, a short term mutual fund is a convenient investment option to help meet your short-term financial goals with minimum risk. 

 

Find various mutual fund options and schemes on Bajaj Markets. Applying through this platform provides the benefit of a simple application process and minimal documentation.

FAQs on Short Duration Funds

Do I need to pay an exit load on short duration funds?

You may have to pay an exit load while withdrawing your short-term mutual fund before maturity. Different schemes have different rules regarding the exit load.

Can I invest in short duration funds through an SIP?

Yes, you can invest in a short-term mutual fund via a systematic investment plan (SIP) easily.

What is the ideal investment duration for short duration funds?

The ideal investment period for a short-term mutual fund is at least 1-3 years.

Is investing in short duration funds risky?

Investing in a short-term mutual fund comes with some volatility. Still, you can reduce it by opting for a shorter timeline of less than 1 or 2 years.

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