A Comprehensive Guide to Short Term Funds

Mutual funds

Short term funds are open-ended debt mutual funds with investment duration ranging from one month to three years. According to SEBI’s regulations, short-term funds can be considered as investments for a short duration (less than 5 years). These funds may provide greater returns depending on the market conditions. 

If you are looking for an investment option which provides good returns compared to traditional Fixed Deposits (FDs) with a short maturity period, start investing in a short term fund. Here are the benefits, taxation, and things to consider before investing. Read on!

What are Short Term Funds?

Short Term Funds are debt mutual funds for a short duration of 1-3 years. These funds invest in debt funds and are moderately low in risk. A short term fund provides better returns than bank fixed deposits and offers better tax benefits if held for more than 3 years. If you have idle money to invest and get better returns, a short term fund is for you. Check out the list of benefits of investing in a short term fund in the section below.

Benefits of Short Term Funds  

Here are some of the benefits of short duration mutual funds for your reference:

• Helps Reach Financial Goals 

Whether you want to invest your money for less than a year or a period of three years, short term mutual fund schemes can be a favourable investment option in terms of returns. They provide a higher post-tax return compared to other investment avenues such as fixed deposits.   

• Offers Portfolio Diversification 

Short duration debt mutual funds help to balance and diversify your portfolio. These schemes are less risky than equity mutual funds that involve longer investment tenure and can offer attractive returns within 3 years. 

• Provides Stable Returns   

Mostly all short-duration funds are debt mutual funds that have been categorised based on the holding tenure. Debt mutual funds are safer than equity mutual funds since they invest in fixed income instruments such as money market securities, treasury bills, corporate bonds and government securities. 

Hence, these schemes can earn a fixed return for pre-specified maturity date. The top-performing short term funds of India are usually less prone to the effects of capital market fluctuations. 

Also Read: Best Short Term Mutual Funds In India: Should You Invest?

Taxation of Short Term Funds 

With respect to taxation, short term funds can be classified into growth or dividend options. In the growth option, your investment will be recognised as fixed bank deposits. The interest you earn on your fixed deposit will be taxable. A TDS of 10% will be applicable. The overall gains from these short term mutual funds will be treated as a portion of your earnings and taxed according to tax slabs. 

Who can Invest in Short Term Funds?

Investors who want to invest for a duration of one year to three years can choose these funds. Short term funds are suitable for risk-averse individuals who need liquidity and favourable returns. First-time investors who want to create a portfolio of debt mutual funds can also avail of these funds. 

Disadvantages of Short Term Funds  

Though these schemes involve lesser risk than equity mutual fund schemes, they still have their own limitations. Here’re some of the probable risks associated with these funds:

• Liquidity Risk

While these schemes are more liquid relative to regular instruments, the flexibility differs from one scheme to another. You should choose a short duration fund that provides you with the flexibility that you are looking for.   

• Inflation Risk 

Inflation can have a negative impact on these funds as it may increase the rate of interest exponentially. As a result, the value of your investment will fall, and the returns will be cut down. 

• Variable Interest Rate 

The prevailing interest rate influences a debt fund’s NAV (Net Asset Value) and returns. A high-interest rate will reduce your profits. Similarly, it will reduce the mutual fund price. Hence, fluctuations in interest rates can impact your investment. 

• Credit Risk   

Short term funds come with credit risks. Credit rating firms such as CRISIL give ratings to short-duration debt funds ─ that denotes their risk exposure and credit quality. So, investments in these schemes will expose an investor to credit risks in case the company turns a defaulter. 

Things to Consider for Investing in a Short Term Fund

You need to keep the following factors in mind before you invest in a short term mutual fund: 

• The expense ratio of the fund
• Track record of the fund manager
• Mode of investment
• Direct or regular plans
• Past performance
• Investment objective
• Risk appetite

Also Read: Hybrid Mutual Funds: Types, Benefits, Risks & Returns

Final Word    

Short term funds are moderate return and low-risk mutual funds that can help to diversify your portfolio. If you have some idle money to invest, you can opt for these funds to achieve your financial goals.

You can also opt for short term funds from Navi such as Navi Ultra Short Term Fund-Growth, Navi Ultra Short Term Fund Super Institutional Plan Direct-Growth. Navi offers quick and hassle-free mutual fund investment with a minimal expense ratio. Visit Navi Mutual Fund to know more. 

FAQs on Short Term Funds

1. Is there any expense ratio for short term funds?

Yes, short term funds have expense ratio. Short term funds require active management and are volatile, there may be some expenses involved to manage your fund. Fund managers impose a charge as a ratio of the gains and returns earned on your investment. This is what an expense ratio is.

2. What is the return potential of short term funds? 

Since short term mutual funds come with a shorter period and with a low risk, the returns are relatively low. Debt funds with short term come with a return potential ranging between 7% and 8%, depending on your portfolio. 

3. Does a mutual fund facilitate tax deduction?

Yes, you can avail tax deductions through investment in ELSS (Equity Linked Savings Scheme). As per Section 80C of the Income Tax Act, 1961, individuals investing in ELSS funds can claim a tax deduction of up to Rs. 1.5 lakh every year. 

4. Can I use SIP mode to invest in short term funds?

Yes, you can invest in short term funds through a Systematic Investment Plan (SIP). This facility allows an individual to invest a fixed sum at pre-determined intervals such as monthly, quarterly, annually, half-yearly and weekly.   

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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.

This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.