Best Short Term Mutual Funds | Top Short Term Funds in India (2024)

What is Short Duration Mutual Fund

To understand how short-duration funds work, it is necessary first to understand the concept of duration and how it impacts the funds' investment decisions and returns.

• Understanding Duration: The duration of a debt fund measures the extent to which the value of a fund fluctuates in response to changes in market interest rates. Duration represents interest rate risk. The higher the duration, the more volatile the fund value, and the greater its interest rate risk. There is a complex formula for calculating duration. Still, for most retail investors, it is enough to remember that the duration of a debt fund is closely linked to the maturity of bonds in its portfolio. Funds holding more long-maturity bonds have higher durations as compared to funds that hold mainly short-term securities.
• Defining Short Duration: According to SEBI norms, short duration funds are expected to have durations between 1-3 years. This means that short duration funds can invest in the short term as well as slightly longer-term debt securities. In terms of interest rate risk, short duration funds are positioned at the lower end: higher than liquid, ultra-short duration, and low duration funds but lower than medium and long duration funds.
• Where do short duration funds invest?: Short duration funds invest in a range of debt such as corporate bonds, government securities, securitized debt, derivatives, bonds issued by financial institutions, and public sector enterprises. They also hold a part of their portfolio in money market assets such as treasury bills, TREPs, commercial paper, or certificates of deposits to maintain liquidity. There are no credit quality norms for short duration funds; hence, they can invest in lower-rated debt to earn higher yields. The extent of exposure to lower quality debt will depend on a fund's investment style and prevailing credit/market conditions.
• Sources of Earnings:: Short duration funds earn through interest as well as capital gains. Interest is generated from interest payments on the fund's debt holdings. In addition, when interest rates are falling in the market, the value of securities held by the fund increases, resulting in capital gains. Of course, when interest rates go up, the fund makes capital losses. The extent of capital gains or losses earned by a fund depends on its duration and the movement in market rates at that point. Short duration funds actively manage duration to benefit from changing interest rates. In general, short duration funds with higher exposure to long-term securities face more capital gains or losses. Funds that maintain durations at the lower end of the 1-3 year range are less likely to make capital gains or losses.

• Investors with an investment horizon of at least one year: Short-duration funds are usually recommended for investors who are willing to stay invested for at least one year; in fact, a horizon of 1-3 years may be better to get the best returns. An investor who redeems within a year may end up with capital losses if he or she exists when interest rates are rising. Thus, investors with shorter holding periods should opt for liquid funds or ultra-short duration funds.
• First-time investors in debt funds: Investors who want to start building a portfolio of debt funds can begin by investing in short duration funds. These funds offer market-related returns along with moderate risk. Their returns are usually higher than those earned by liquid or overnight funds, while fund value volatility is lower compared to longer duration funds.
• Investors seeking regular income: Short duration funds aim to provide stable returns, as they have a moderate interest rate risk. Investors with moderate risk appetite can allocate some money to short duration funds and use a Systematic Withdrawal Plan (SWP) to create a stream of income flows. An SWP is a facility that allows investors to systematically withdraw a pre-specified amount from mutual fund investments at regular intervals.
• Investors who want an alternate short-term savings instrument: Short duration funds have the potential to earn more than bank deposits because they earn interest income as well as capital gains. They also earn more than liquid or overnight funds as they invest in relatively longer-term debt. In a rising interest rate market, such funds benefit from high short-term spreads. In a falling interest rate market, these funds may take exposure to longer tenor bonds to earn some capital gains.

Investors earn dividend income and capital gains from short duration funds. From the financial year 2020-21, investors will pay tax on dividends as per their tax bracket. Capital gains- or the difference between the purchase price and the selling price of the fund- are taxable. How capital gains are taxed depends on the length of time for which an investor holds the units of a debt fund before sale or redemption.

• Short-term capital gains: If the units of a short duration fund are held up to 3 years, capital gains on sale are considered short-term capital gains and taxed at the income tax slab rate applicable to the investor.
• Long-term capital gains: If a short duration fund is sold after being held for more than 3 years, capital gains are classified as a long-term capital gain for tax purposes. For long-term capital gains, investors get the benefit of indexation. This means that before calculating capital gain, the purchase price can be increased using an index provided by the Government, thus reducing the final taxable capital gain amount. Long-term capital gains are currently taxed at a rate of 20% post indexation.

It is quite easy to invest in Short Duration mutual funds on ET Money. Here are the steps that you have to follow.

• Register online on ET Money app or website
• Head to Mutual Funds sections and choose the Short Duration fund you want to invest in.
• Click on invest and choose the amount and mode of investment (SIP or Lumpsum)
• Provide your KYC details (Pan number, Bank details) and complete your investment.