For most Indians, a traditional savings plan comes naturally to us. However, short-term debt funds provide a wide range of options with easy accessibility.
You may be comfortable with conventional savings products, but debt funds offer better features. However, to understand the advantages of short-term debt funds, you may want to consider investing in them.
Here, we look into debt funds, short-term debt funds and the advantages of investing in these funds to achieve your investment goals.
What are Debt Funds?
Debt funds are types of mutual funds that invest in fixed-income generating securities. These include government securities, money market instruments, treasury bills, corporate bonds and other such instruments.
Generally, a portfolio manager charges a total expense ratio when he invests in mutual funds on your behalf and manages your investment portfolio.
What are Short-Term Debt Funds?
Short-term debt funds refer to an investment scheme of mutual funds with a maturity period of 1 to 3 years. They offer high liquidity along with modest risks and stable returns. Short-term debt funds get compared to fixed deposits (FDs) quite often as both the financial instruments offer similar investment terms.
However, as compared to an FD, a short-term debt fund can be more tax-efficient over three years. For example, some short-term debt funds have ensured returns of up to 9.48% in one year as compared to the average return rate of FDs between 6% and 8%.
Advantages of Investing in Short-Term Debt Mutual Funds
Following are the reasons that make short-term debt funds a smart investment option.
Debt funds have a pre-determined date of maturity and offer a fixed rate of return. Hence, debt funds are preferred over equity funds by investors.
They remain unaffected by capital market movements and are less risky. Debt funds are generally classified into floating-rate funds, liquid funds, ultra-short-term funds and corporate bond funds. Depending upon the type of debt fund you invest in, tax implications can differ.
Short-term funds may not provide returns as high as equity mutual funds, but they play an essential part in an asset allocation strategy. Since their risk levels are low to moderate, they can be used to diversify your investment portfolio to avert risks caused due to market fluctuations.
Besides, short-term debt funds are less sensitive to inflation as compared to long-term funds and can be easily converted into cash as well.
Achieve Financial Objectives
Short-term debt funds can meet your financial goals between one to three years or even lesser than a year. When compared with other non-equity funds of the same tenure, they offer higher post-tax returns.
Ultra-short-term funds provide high returns as they do not attract any pre-mature redemption penalties, unlike equity funds. Such funds also offer better protection against interest-rate fluctuations due to the lower average maturity period.
Who Should Invest in Debt Funds for a Short Term?
You may be looking to invest in mutual funds but prefer not to take high risks. In this case, short-term debt funds can be an excellent option to get you started on your investment journey.
The primary reason is that tax-adjusted returns are better for short-term debt funds compared to traditional forms of investments, such as fixed deposits.
You can choose to invest in high-credit risk securities; these include high-yield bonds or high-risk securities to compensate for a low-yield environment.
Short-term debt funds are ideal investment instruments for a financial goal period of 1 to 3 years. However, it can be a good idea to retain it for a more extended period to receive better returns.