Short term mutual funds, have you heard of it? They are debt-oriented investment options where the capitals are allocated to financial instruments that have relatively shorter maturity periods. The time horizon of these funds ranges from a few months to a few years.
The prime objective behind investors choosing short-term funds is capital preservation while generating modest returns. Additionally, the shorter time frame allows investors to quickly gain access to their funds in case of an emergency.
Moreover, they are the best investment options to plan for an emergency or any short-term financial goals beforehand, so that you stay financially stable. More than that, it is the best way to park your surplus funds so that you don’t commit the amount to fulfill any of your wants.
In this blog, let’s dive deeper into some of the best short term mutual funds, advantages, factors you need to consider before investing in them, how they work, taxation, and more. Continue reading to further explore the intricacies of short-term mutual funds.
Key features of short-term mutual funds
Listed below are a few key features of short term mutual funds that you should know:
- They can be defined as low-risk, high-quality funds with a limited maturity period.
- These funds have different durations starting from 91 days to 3 years.
- Relatively low risk compared to equity funds due to the shorter maturity period of underlying securities.
- Returns are relatively higher than a fixed deposit and a savings bank account.
- Higher liquidity ensures easy access to your funds.
- Overall, this fund type is most suitable for risk-averse investors.
Best short term mutual funds based on 5-year CAGR
Here is the list of the best short term mutual funds that you can explore for your next investment:
- Bank of India’s short-term income fund
- UTI Short duration fund
- ICICI Prudential short-term fund
- Aditya Birla SL short term fund
- HDFC short-term debt fund
- Nippon India’s short-term fund
- Axis short-duration fund
- Kotak bond short-term fund
- Sundaram short duration fund
- Tata ST bond fund
Important factors to keep in mind before investing in short-term mutual funds
Although, investing in short-term funds seems to be a lure to meet your short-term needs, however, you need to consider the below-mentioned factors prior to investing. Without any further ado, let’s explore those key factors:
1. Investment objective
Firstly, it’s quite important for you to be aware of your investment objectives and goals. Many people don’t actually know what their financial goals are.
Investment objective is the prime factor that you need to take into consideration as it will help you assess whether you should invest in short term mutual funds or not. If you are financially preparing yourself for any upcoming emergency or need to meet any short-term goal, you can choose to go with short-term funds.
2. Investment tenure
Different types of mutual funds serve different purposes, and they are made for different investment horizons. Likewise, short term mutual funds are specifically designed for your near-term goals starting from 3 months to 2 years.
Therefore, you must always evaluate before investing whether you’ll need that capital in the near term, if yes, you can go with short-term funds.
3. Diversification
The key to earning good returns and to hedge the risk at the same time is diversification. It should be done by keeping your investment objective and tenure in mind, if you over-diversify or under-diversify, you’ll end up losing returns.
Therefore, thorough diversification is crucial as it helps in aligning your funds to your goals. Examples include choosing the best ultra short term or short term funds for your next year’s financial goal.
4. Expense Ratio
The next big thing that you must consider before making an investment in any fund is its expense ratio. Basically, it is the amount charged annually by the fund house to manage your investments. The expense ratio of debt funds is relatively lower than that of equity funds as there is nothing more to be done by fund managers.
Remember, the lower the expense ratio, the higher the returns. Thereby, you should always consider the expense ratio to make sure that the fund managers do not entirely benefit from your funds.
5. Tax Implication
Tax, a word hated by HNIs (High Net-worth Investors) is another major factor that you need to keep in mind before investing in short term mutual funds. Short term funds for 1 month or growth options are taxed as per the investor’s slab rate which impact returns significantly.
6. Past Performance
You might have heard something like this in the mutual fund disclaimer’ “past performance does not guarantee future returns”. You should know that the mutual fund returns depend on the market movements and the fund manager’s expertise. No one can accurately predict the future return based on past data.
For example, when checking out the best mutual fund for 6 months or the best short-term fund for 3 months, never rely completely on past performance.
7. Holding Analysis
Analyzing the holding is the best way to decide if the fund aligns with your investment goal or not. For example, some short term mutual funds invest substantially in high-quality securities, facilitating stability and moderate returns. While others might lean toward low credit-rating securities, promising higher returns.
8. Risk Profile
Last but not least, the fund’s risk profile is another major factor to consider before investing. Before starting SIP in a short-term mutual fund, you must evaluate the liquidity risk, credit risk, and interest rate risk.
How do short-term mutual funds actually work?
Wondering how short term mutual funds generate returns while keeping risks low? These funds pool money from multiple investors and invest in secure, short-term debt instruments like government bonds, corporate papers, and money market securities.
Here’s a simple breakdown:
- Professional Management: A fund manager selects and monitors investments to balance safety and returns.
- Lower Volatility: Since holdings mature in 1–3 years, price fluctuations are minimal compared to equity funds.
- NAV-Based Pricing: Returns depend on the Net Asset Value (NAV), which reflects the fund’s underlying assets minus expenses.
- Liquidity: Most funds allow easy withdrawals, making them suitable for short-term goals.
While they offer stability, returns are generally moderate—ideal for conservative investors or parked funds.
Investors should carefully compare funds, assess costs, and align choices with your financial plan for optimal results. Clarity today ensures better decisions tomorrow.
Advantages of Short-Term Mutual Funds
Short term mutual funds are a smart choice for investors looking to grow their money without constant monitoring. They offer a balanced mix of returns, flexibility, and tax benefits, making them a great alternative to traditional options like fixed deposits.
- Perfect for hands-off investors: If you can set aside your money for 6 to 18 months, short term mutual funds—or even a 6-month SIP—can be a hassle-free way to grow your savings.
- Better returns than FDs, with controlled risk: Compared to fixed deposits, these funds often deliver higher returns while keeping risk in check, making them a smarter short-term investment.
- Tax efficiency for long-term holdings: If you stay invested for 3+ years, you benefit from lower tax rates compared to FDs or regular savings accounts.
- Easy access to your money: Need cash quickly? These funds are highly liquid, allowing you to withdraw or redeem units anytime without heavy penalties or delays.
- Flexible investment timelines: Whether you’re saving for 3 months or 18 months, short term mutual funds adapt to your needs while keeping your money working for you.
Who should invest in this fund?
Listed below are a few key points that describe who should invest in short term mutual funds:
- Passive investors or ones seeking regular income.
- Investors with an investment tenure of 1 to 3 years or more.
- First-time debt-fund investors
- Investors seeking alternative short-term saving instruments rather than savings or fixed deposits.
- Who seeks high liquidity and tax efficiency.
- Risk averse investors.
Conclusion
Short term mutual funds can be a smart choice if you’re looking for high returns with relatively lower risk. While they’re not entirely risk-free, their flexibility and potential for moderate gains and quick liquidity make them appealing.
Remember, always align your picks with your financial goals and risk appetite. Research thoroughly or consult an expert, because even small decisions can have a big impact on your portfolio.
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