11 Mins

Short term debt mutual funds are short-duration investment opportunities that possess low risk, tax efficiency, and moderate yield. They are a great alternative to traditional instruments like a bank’s savings account or fixed deposits. Investing in short term mutual funds through Systematic Investment Plans (or SIPs) is a much more attractive alternative to recurring deposits. All in all, short term debt funds are perfect for parking your idle money.

Sheetal and Malvika were planning a celebratory trip to Hong Kong. However, due to the political unrest there, they decided to cancel the trip indefinitely. Sheetal has some spare cash that she had withdrawn for the trip, which she now wishes to deposit in her savings bank account.

“Are you going to let this money sit idle in your savings account and earn a meagre interest on it? Why don’t you invest this money in mutual funds? At least you will earn better returns!” asks Malvika.

“I could but what happens if I need this money in the near future? Aren’t mutual funds investment tools for the long term? I wouldn’t want to stash my money for that long!” says Sheetal.
Malvika shakes her head and says, “Let me tell you a thing or two about short term investment plans.”

If like Sheetal, you have some extra money at hand that you wish to invest while also diversifying your portfolio, then you must consider short term funds! Here is a comprehensive guide on everything that you need to know about short term mutual funds.

Short Term Mutual Funds
short term mutual funds

What are Short Term Mutual Funds?

If you are looking to park your short term money and earn a good return on the sum, then you may break away from the traditional saving instruments and opt for short term mutual funds.

Did you know? As per SEBI’s guidelines, there is nothing specifically termed as short term mutual funds, which basically means that there is no such thing as short term mutual funds! Thus, technically, rather than being a categorization, short term mutual funds are investments made for a brief period of less than 5 years.

Some kinds of debt funds can be considered short term mutual funds. Also known as short duration schemes, these are open-ended debt schemes available for short durations. You could invest in this mutual fund for 1 month or a couple of years, depending on the availability of the money at your disposal. Typically, the Macaulay (average) duration for short term funds ranges from one year to three years (and may be extended up to four years).

Short term mutual funds like ultra-short duration funds or short-duration funds in India offer stable returns and low to moderate risks. Thus, they are comparable to Fixed Deposits (FDs) offered by banks. Conventionally, Fixed Deposits are considered to be the best saving plan for short term money.

short term mutual funds scaled

However, if you have invested in the best short term debt funds you can expect higher liquidity, greater tax efficiency, and better returns (an average of 10% against 7%) when compared to fixed deposits. Additionally, redeeming FDs before maturity period attracts a penalty of 1% while redeeming short term mutual funds after a short period (could range from 5 days to 6 months) does not attract any penalty!

Clearly, short term funds have an edge over FDs.

Who Should Invest in Short Term Funds?

Investors who are looking for low-risk investment avenues while making decent tax-adjusted returns could choose short term mutual funds. As such, you can preserve your capital investment while drawing a moderate yield by investing in the best mutual funds for the short term.

Benefits of Short Term Mutual Funds

After knowing the advantages of short term mutual funds over fixed deposits, you may be interested in knowing the other benefits of mutual funds for the short term. Here are a few reasons why you should trust mutual funds the best short term investment plans:

Stable Returns on Investment

Almost all short term funds are debt funds, which have been classified on the basis of the holding period. Debt funds are more reliable than equity funds as they put your money in fixed income securities such as Government Securities, Corporate Bonds, Treasury Bulls, and Money Market Instruments (and more).

best short term mutual funds

As a result, short term debt mutual funds have the capacity to generate a fixed rate of return for a predetermined date of maturity. Further, the best short term debt funds of India are generally immune to the capital market movement.

Diversifies Your Portfolio

Short term debt funds help in diversifying and balancing your portfolio. Unlike equity investments, which require a longer duration, short term debt funds can not only avert risks but also offer attractive returns for investments within a period of 3 years.

Helps Meet Your Financial Goals

Whether you wish to park your money for less than a year or a maximum period of three years, short term debt mutual fund investments are ideal for short term investment plans with good returns. They continue to offer attractive returns on the investment. It is because of the fact that they offer a higher post-tax return than their counterparts.

Risks or Limitations of Short Term Mutual Funds

While short term debt mutual funds definitely are less risky, when compared to equity funds, they still carry their own risks and limitations. Here are some of the possible risks while investing in short term mutual funds:

Credit Risk Exposure

Any short term debt Mutual funds for short term carries with it a varied credit risk. Credit rating agencies such as CRISIL award ratings to short term debt funds, which indicates their credit quality and risk exposure. Thus, investments in short term debt mutual funds will expose you to credit risks if the company happens to default on their payments.

Variable Rate of Interest

The NAV of a debt mutual fund and the returns offered by it are controlled by the prevailing rate of interest. A high rate of interest will eat into your gains and vice versa. Similarly, a higher interest rate brings down the mutual fund price and the converse also stands true. Thus, having a fluctuating interest rate could affect your investment.

Low Maturity Period Risks

You need to check the average maturity value of the short term debt mutual fund to understand the interest rate risk. Thus, having a low maturity period will result in a minimum impact arising out of the change in interest rates.

Inflation Risks

Inflation could negatively impact short term debt mutual funds by increasing the interest rates exponentially, thereby bringing down the value of your investment, or cut down on the returns on your investment.

Liquidity Risk

While short term debt mutual funds are more liquid than traditional instruments, the flexibility in terms of liquidity varies from one fund to another. Thus, depending on your requirements, opt for a short term debt mutual fund that gives you the flexibility that you need.

Return Potential and Taxation of Short Term Debt Mutual Funds

Depending on the assets that you have selected the best debt mutual funds for the short term will yield returns ranging from 7% to 8% as per your portfolio. he post-tax returns for short-term mutual funds are also attractive. In terms of taxation, short term debt mutual funds can be categorized into dividend or growth options. Under the growth option, the investment will be treated at par with the bank’s fixed deposits. The total gains made from short term funds will be considered as a part of the investor’s income and taxed accordingly. On the other hand, under the dividend option, the income earned from mutual funds investment for the short term is exempted from taxation.

Factors to Consider Before Investing in Short Term Debt Mutual Funds

Before we get into the best mutual funds to invest for short term, here are a few things that you must consider:

Expense Ratio

Since most short term debt mutual funds are volatile in nature and need active management, there may be some amount of cost involved in managing your funds. This fee charged by fund managers as a ratio of the returns and gains made on your investment is known as the expense ratio. Knowing the expense ratio will help you understand the extra charges that you will have to pay.

Risk Tolerance

If you are looking for a low risk, low to average yield, then investing in short term debt mutual funds would be ideal for you. Since fund managers normally pick investments with high credit ratings, there is little to no risk involved in this form of investment.

Tax Implications

When compared to other investment options, short term debt mutual funds are much more tax efficient. The taxation on short term debt funds is subject to indexation if held for over three years and has been discussed earlier.

Investment Horizon

Short term debt mutual funds are highly liquid as your capital is highly accessible. While the average duration for the best short term debt investments ranges from six months to three years, you may also invest in short term debt funds for longer durations. Exit Load

If you happen to redeem your short term funds before the completion of a few days or months (depending on your investment), you may be charged an exit load. Thus, before you exit your investment, check out the exit load that you may be charged.

Know why investing in good short-term debt funds can be great for your equity investments.

List of Best Short Term Mutual Funds

Here are some of the best short term funds, as recommended by Scripbox:

Kotak Savings Fund (G)

Previously known as Kotak Treasury Advantage Fund, the Kotak Savings Fund was launched on August 13, 2004. It is registered as an open-ended, ultra-short duration debt fund. The short term fund charges 0% exit load, thereby offering your investment higher flexibility and greater liquidity.

Here’s an overview of the Kotak Savings Fund (Growth):

Fund HouseKotak Mahindra Mutual Fund
Risk GradeAverage
Return GradeAverage
Minimum Investment (in INR)5,000
Minimum SIP Investment (in INR)1,000
Minimum Withdrawal (in INR)1,000
Minimum Balance (in INR)1,000

Let’s take a look at the fund performance for one-time investment:

Period invested forAbsolute Returns (%)Annualized Returns (%)Category Average (%)
1 week0.160.14
6 months3.913.35
1 year8.438.437.23
3 years23.707.346.61
5 years46.107.877.43
10 years118.408.127.93
Since inception212107.796.97

Let’s take a look at the performance for short term fund SIP investments:

Period Invested forAbsolute Returns (%)Annualized Returns (%)
1 year4.48.25
2 year8.47.96
3 year12.237.64
5 year21.37.65
10 year52.438.17

ICICI Prudential Savings Fund (G)

ICICI Prudential Savings Fund, formerly known as the ICICI Prudential Flexible Income Scheme, was launched on the 27th of September 2002. It is registered as a NIFTY low duration debt TRI as an open-ended fund. The short term fund levies 0% exit load, so you can have your investment as cash in no time!

Here’s an overview of the ICICI Prudential Savings Fund (Growth):

Fund HouseICICI Prudential Mutual Fund
Risk GradeBelow Average
Return GradeHigh
Minimum investment (in INR)100
Minimum SIP Investment (in INR)500
Minimum Withdrawal (in INR)100
Minimum Balance

Let’s take a look at the fund performance for one-time investment:

Period Invested forAbsolute Returns (%)Annualized Returns (%)Category Average (%)
1 week0.160.16
6 months4.38-1.09
1 year8.998.993.23
3 years24.767.655.39
5 years48.718.256.59
10 years123.898.387.01
Since Inception275.188.067.19

Let’s take a look at the performance for short term fund SIP investments:

Period Invested forAbsolute Returns (%)Annualized Returns (%)
1 year4.829.04
2 year8.858.38
3 year12.767.96
5 year22.468.04
10 year55.188.51

You might also want to read Short-Term Investing Could Chop Off One-Fourth of Your NAV Gains

In Conclusion

The minimum amount to invest in mutual funds in India in the case of short term debt funds is Rs 1000 for a 12-month SIP. Hence, if you have some idle cash lying around that you would wish to gain from, then you may opt to invest it in short term mutual funds. Put your money in the best short term funds for one to three years and earn attractive returns.

Short term debt funds are low risk, average yield funds that are invested for short durations. Thus, you can not only gain returns on your investment, save on tax, but also have liquid money readily available. Investing in short term debt mutual funds will diversify your portfolio and balance out your investment in equity. At the same time, it will also help you reach your financial goals.