Know whether short-term mutual fund schemes are suitable for you for investment?

If you are searching for investment options that are short-term in nature and that give reasonable returns, you may invest in short-term mutual fund schemes. Short-term mutual funds are suitable for investors with a medium risk-taking capacity.

What are short-term mutual fund schemes?

The short-term mutual fund schemes invest in debt securities, such as bonds, securitised debt, government securities, money market securities (treasury bills, commercial papers, certificate of deposits, etc.). These schemes are available with a duration of one to three years and are highly liquid in nature.

Advantages of investing in short-term mutual funds

• Stable returns: It offers better returns than those offered by ultra-low risk investments, such as fixed deposit schemes by the banks, etc.
• Highly liquid: They are highly liquid and easily convertible into cash. They can be a source of emergency funds because of their liquid nature.
• Moderate risk: The risk involved with short-term mutual funds is much lower than the risk in equity funds.
• Higher tax efficiency: The investors holding short-term debt mutual funds for more than 36 months can receive indexation benefits, i.e. the purchase cost is adjusted with inflation while computing the capital gains.

What are the risks involved with short-term mutual funds?

Short term mutual funds are not free from their flaws. There are some of the risks that accompany these funds. Let’s see the risks involved with short-term debt funds.

• Inflation-Rate Risk – As inflation rises, the fixed income value delivered by the bonds and money market securities becomes less. Hence, these debt funds are ideal for investors with short-term financial goals stretching up to 2 or 3 years. Therefore, if you want to make a long term investment, you cannot consider investing in such funds.
• Credit Risk– The underlying assets of the short-term debt mutual funds carry a credit risk. Before investing, it is important to check whether the underlying assets of the debt funds have a high credit rating with a safe track record.
• Interest Rate Risk– Though the impact is marginal, changes in interest rate in the economy do affect short-term debt funds. However, given the short maturity period of these funds, the interest rate changes have a marginal effect on the value of these funds.

For any clarifications/feedback on the topic, please contact the writer at namita.shah@cleartax.in