Short-term mutual funds are a part of the debt category mutual funds. They invest in a range of debt securities such as corporate bonds, securitized debt, government securities, derivatives, bonds of financial institutions, and public sector undertakings (PSUs). They also have investments in money market instruments like T- bills, commercial paper, certificate of deposits (CDs), etc. The duration of the fund’s portfolio is between 1 to 3 years.
How do short-term mutual funds work?
Some short-term mutual funds offer higher returns as compared to bank deposits. The returns could range from 8 to 9%, depending on the assets included in the fund portfolio. Including the tax benefits, the returns on short-term mutual funds are higher than the post-tax returns offered by most other forms of investments.
Short-term mutual funds earn interest/ dividend income on the debt holdings in the portfolio. Besides interest income, short-term mutual funds give capital gains. Capital gains occur in the falling interest rates scenario. When the interest rates fall, the value of securities held by the mutual fund increase. However, there may be capital losses when the interest rates rise. The extent of gains or losses incurred is directly related to the fund’s duration and the interest rate movement in the said duration.
Taxation of short term mutual funds
There are mainly two ways in which investors earn by investing in short-duration debt mutual funds.
- Through the dividend income, and
- Capital gains.
Dividend income is taxable as per the individuals’ applicable slab rates. Capital gains are taxable, too, but the rate depends on the length of the time that the investor holds the units of the debt funds. Here are the two broad tax categories on income from short term mutual funds:
- If the short-term mutual funds are retained for less than 3 years before redemption, the gains earned are termed short-term capital gains. Such gains made are taxable as per the investor’s slab rates.
- If the short-term mutual funds are retained for over 3 years before the sale/ redemption, the profits incurred are called long-term capital gains. Long-term capital gains on these short-term mutual funds are taxed at 20 percent.
Investors also benefit from indexation in the case of long-term gains, which reduces the overall tax amount.
Who should invest in short-term mutual funds?
Before investing in short term mutual funds, investors can look through the below points which will help in understanding the suitability of these investments to individual financial goals:
- Short term mutual funds belong to the debt category. Hence, they are suitable for investors who want a fixed income and, at the same time, enjoy a little better return from a bank FD (Fixed Deposit). Short term mutual funds earn interest income along with capital gains, so the returns are better than FD or liquid funds. Investors looking for an alternative to traditional instruments like bank FD can invest in these funds.
- These funds have lower volatility than long-duration mutual funds. So investors who do not prefer volatile investments can also invest in such funds by taking moderate risk. Ideally, short-term funds are suitable for investors who are building their debt portfolio.
- Investors should understand that they need to have a minimum holding period from 1 to 3 years in case they invest in short duration mutual funds. If the individual redeems funds within one year, he/she may witness capital loss if the redemption is made when the interest rates are rising. Therefore, the time horizon for short-term funds should be at least 1 to 3 years for getting the best returns out of them.
Best short term mutual funds for 2022
Short-term mutual funds are gaining popularity. First-time investors or the investors who are starting building their debt portfolio are increasingly getting attracted to these funds. These funds are low in volatility, offer better returns than overnight, liquid, and ultra-short funds. So if you feel short term mutual funds are suitable for you, here are the best short term mutual funds you can invest in :
SBI Short Term Debt Fund
About the Fund
The scheme aims to provide investors regular income by investing in a portfolio that predominantly comprises debt and money market instruments with an investment-grade rating. It aims to maintain the portfolio’s Macaulay duration between 1 to 3 years.
| Inception Date | January 01, 2013 |
| Expense Ratio (Direct) | 0.35% |
| Fund Manager | Rajeev Radhakrishnan |
| Suitable For | Investors who want to remain invested for 1-3 years and are willing to explore alternatives to bank deposits. |
Historical Returns of the Fund (annualised)
| 1-Year | 2-Year | 3-Year | 5-Year | 10-Year |
| 3.33% | 6.76% | 7.87% | 7.33% | 8.23% |
Kotak Bond Short Term Fund
About the Fund
Kotak Bond Short Term Fund is a debt mutual fund scheme with 96.46% investment concentrated in debt. Of this, 42.28% is allocated to Government securities and 54.18% is invested in very low-risk securities. This fund has consistently beaten the category average returns. The three- year average returns of the fund are about 8 percent.
| Inception Date | January 01, 2013 |
| Expense Ratio (Direct) | 0.34% |
| Fund Manager | Deepak Agrawal |
| Suitable For | Investors who want to remain invested for 1-3 years and are willing to explore alternatives to bank deposits. |
Historical Returns of the Fund (annualised)
| 1-Year | 2-Year | 3-Year | 5-Year | 10-Year |
| 4.08% | 7.42% | 8.44% | 7.82% | 8.53% |
IDFC Bond Fund-Short Term Plan
About the Fund
This scheme from IDFC AMC seeks to generate returns by investing in debt and money market instruments. The portfolio of this fund is primarily a mix of short duration debt and money market instruments. The average portfolio maturity is anchored around 2 years. The fund aims to generate optimal returns over short to medium term.
| Inception Date | January 01, 2013 |
| Expense Ratio (Direct) | 0.30% |
| Fund Manager | Mr. Suyash Choudhary |
| Suitable For | Investors who are looking to diversify their portfolio with a mix of short duration debt and money market instruments. The average portfolio maturity does not exceed around 2 years. |
Historical Returns of the Fund (annualised)
| 1-Year | 2-Year | 3-Year | 5-Year | 10-Year |
| 3.87% | 6.96% | 8.08% | 7.56% | 8.34% |
Axis Short Term Fund
About the Fund
Axis short-term fund primarily invests in a portfolio of money market instruments and high-quality debt securities. Investors can consider this fund if their investment horizon is between 1 to 3 years. This fund is rated as moderate risk. The fund has given healthy returns of around 9 percent since its inception.
| Inception Date | January 01, 2013 |
| Expense Ratio (Direct) | 0.30% |
| Fund Manager | Mr. Devang Shah |
| Suitable For | Investors who are looking for stable returns with a low risk strategy and high liquidity. |
Historical Returns of the Fund (annualised)
| 1-Year | 2-Year | 3-Year | 5-Year | Since Inception |
| 4.22% | 7.46% | 8.47% | 7.86% | 8.62% |
Conclusion
Investors can build a smart investment portfolio by including some of the best short term mutual funds which can help in minimising the overall risk exposure. However, before investing in any fund, investors must read through the scheme documents and other statistics to arrive at an informed conclusion. Now, investors can easily invest in mutual funds through the Fisdom app by downloading it on their smartphones.
Frequently Asked Questions
What are debt funds?
A debt fund is a mutual fund that invests money in fixed income instruments such as government and corporate bonds, treasury bills, commercial paper, certificates of deposit, etc.
How to invest in debt funds?
Investors can invest in direct plans of debt fund schemes through the respective asset management company. Investment can also be made in regular plans of debt fund schemes through a mutual fund distributor. One of the easiest modes of investment in debt funds is through the Fisdom app, since it is a paperless and hassle-free process.
What are short-term debt funds?
Short-term debt funds invest in bonds that have a maturity period of one to three years. These are ideal for low-risk investors who have a similar investment horizon.
How do debt funds work?
Debt funds aim to fetch returns by investing money in bonds and fixed-income securities. The funds look to earn an interest income by making such investments. The yields generated by investors are based on interest income. Debt funds invest in different categories of bonds, the prices of which can rise and fall depending on interest rate movements in the economy. If a debt mutual fund invests in a bond and its price rises because of falling interest rates, it will get additional income apart from the interest income.
When is the right time to invest in debt funds?
To protect against the volatility of the stock markets, investors must consider investing in debt funds. Including these in an investment portfolio can be beneficial to all investor types. Investors can start investing in debt funds and remain invested for the short to medium term depending on individual financial goals.
