Best Short Term Mutual Funds to Invest in 2022
Short-term mutual funds primarily invest in various debt and money market instruments that have a limited maturity period. The average maturity period of the portfolios of such funds is between 1 to 3 years.
Investing in the best short term mutual funds can be quite fruitful for investors who have surplus funds to invest for a period of 1-3 years. These funds tend to deliver better returns than a savings account or Fixed deposits. However, they tend to be riskier than liquid funds, ultra-short or low-duration funds.
Top Performing Short Term Mutual Funds
Here are some of the best short duration mutual funds to invest in 2022:
|Fund name||3-year CAGR*|
|UTI Short Term Income Fund – Direct Plan (Growth)||8.40%|
|IDBI Short Term Bond Fund – Direct Plan (Growth)||7.98%|
|Bank of India Short Term Income Fund – Direct Plan (Growth)||7.44%|
|ICICI Prudential Short Term Fund-Direct Plan (Growth)||7.39%|
|Aditya Birla Sunlife Short term Fund-Direct Plan (Growth)||7.18%|
|HDFC Short term Debt Fund-Direct Plan (Growth)||6.89%|
|Nippon India Short Term Fund-Direct Plan (Growth)||6.87%|
|Axis Short term Fund-Direct Plan (Growth)||6.79%|
|Kotak Bond Short term Debt Fund-Direct Plan (Growth)||6.55%|
|Tata Short Term Bond Fund – Direct Plan (Growth)||6.28%|
How Do Short Term Mutual Funds Work?
A short duration mutual fund invests its corpus in short term debt securities. The average maturity period of the fund’s portfolio is 1 to 3 years. This is referred to as the Macaulay duration. The securities having higher duration come with high interest rate risks as these are more volatile than low duration securities.
The fund managers of these mutual fund schemes invest in a wide range of debt market securities. These include:
- government and corporate bonds
- commercial papers
- derivatives, etc.
In addition, some part of the corpus is also invested in several money market instruments like treasury bills, certificates of deposits, etc.
As a result, these mutual funds, in the short term, come with low to moderate credit risk. The exact credit risk depends on the fund’s objectives and management’s outlook toward prevailing interest rates.
Fund managers compute the exact duration of a short term mutual fund by using specific formulas. However, for general understanding, duration of this type of fund is tied to the maturity period of corresponding securities. A fund investing in securities having long maturity will come with a higher duration and vice versa.
You will have two sources of earning if you invest in a short duration fund. These include capital gains or appreciation in the value of these funds. The second source of earning is fixed interest payment, which debt issuers pay at regular intervals.
You must know that interest rates and capital gains move in opposite duration; an increase in one leads to a fall in the other and vice versa.
Who Should Invest in Short Term Funds?
You can consider investing in these funds if you are satisfied with the following parameters:
- Investment horizon
As the name suggests, these mutual funds come with a short investment timeline or duration. You can invest your money in these funds if you have an investment horizon of 1-3 years. However, it may not be a suitable investment option if you are seeking long term capital appreciation.
A short term fund or debt mutual fund has moderate return potential. This is because they focus more on generating stable or regular income over aggressive returns. Investors looking for high returns may not find it a feasible investment alternative.
Unlike equity or hybrid mutual funds, a short term mutual fund may be an ideal investment option for new and budding investors. This is because it is considered a low-risk investment and offers stable returns. Most importantly, you are not required to keep track of the portfolio.
What Are the Advantages of Investing in Short Term Funds?
Some of the advantages of short duration funds are given below:
- Stable returns
One of the most important benefits of investing in short term funds is that it offers stable returns with minimal stress or hassles. This fund offers the highest level of stable return among its counterparts.
By investing in a debt fund, you get a chance to diversify your investment portfolio. This reduces the risk associated with your investment basket. This will act as a cushion against unexpected fluctuations or turbulence in equity instruments and reduce capital erosion.
Things to Consider Before Investing in Short Term Funds
Here are some factors that you must consider before investing your money in short term mutual funds:
- Risk appetite
One of the primary things to do before investing in any short term mutual fund is to analyse your risk appetite and see whether it matches your individual risk tolerance level. As these are debt funds having low to moderate risk, therefore, it may be suitable for risk averse individuals or those who are seeking stability over capital appreciation.
- Investment objective
You should also consider your own investment objective before investing in any short term funds. As the name suggests, these funds may be beneficial for fulfilling short term financial objectives like paying off debt, planning a vacation, etc. Investments made in these funds might not be beneficial if you have a long investment horizon.
- Expense ratio
The expense ratio is a percentage value that AMCs levy on investors to cover the operating cost of a particular mutual fund scheme. It varies from one scheme to another, but as this is a direct cost, it may affect profitability of these schemes. Hence, you should carefully analyse the expense ratio of different mutual fund schemes and invest in one which comes with a low ratio.
Taxation of Short Term Funds
These funds are subject to taxation similar to tax related provisions of debt mutual funds. All gains accrued or received from sale of mutual fund holdings are taxable under the head capital gains in various ITRs. The capital gains tax is divided into short term capital gains tax (STCG) or long term capital gains tax (LTCG) as per holding period.
Whenever the holding period of these funds is less than 3 years or 36 months, all gains arising from sale of said mutual fund units come under STCG. On the other hand, as the holding period of these funds crosses 3 years, all gains are subject to taxation as per LTCG tax.
The rates of LTCG and STCG taxes are as follows:
|Type of tax||Rate of tax|
|Short term capital gains tax||As per applicable slab rates|
|Long term capital gains tax||20% with indexation benefits|
The interest amount that investors receive on these investments is exempted from tax.
Short term mutual fund schemes have become a popular mode of investment, particularly among new investors and senior citizens whose main aim is protecting depreciation of their capital. If you are planning to invest in a mutual fund scheme that offers stable, consistent returns and is less risky than equity funds, you can consider investing in short term mutual funds.
FAQs about short term mutual funds
What are the risks associated with short term mutual funds?
One of the biggest risks faced by short term mutual funds is the variable interest rate regime associated with them. NAV of these funds is influenced by changes in market interest rates. An increase in interest rates brings down the value of these funds and vice versa.
What is Macaulay duration of debt funds?
It is the weighted average time period before an investor receives the cash flows from a debt fund. In simple words, it is the length of time it would take for an investor to recover his/her invested money.
What are low duration funds?
Low duration fund is also a type of short term mutual fund which invests in various securities and has a Macaulay duration of 6-12 months. These provide higher returns than savings accounts, bank deposits, etc. Therefore, it is popular among individuals who want to park their surplus money for less than one year.