The Buyt Desk
For most people, the word “mutual fund” means a risk-associated investment that delivers returns upon investing money for the long term. However, this is not entirely true. Short-term debt funds as the name suggests have a 3-year maturity cycle. These debt funds invest in securities of short period. They are a type of mutual funds associated with low risk and a short maturity period. These funds have high liquidity and generate a steady income. The average duration for these funds varies from one to three years, may extend up to a maximum of four years.
Who Should Invest In Short-Term Debt Funds?
Short-term debt funds (also known as Income funds) are an ideal investment option if any of the following are your financial objectives:
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Creation of stable income
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Good return on investment, but without substantial risk
Availability of a financial corpus, which can be invested for one to three years, is another factor for choosing these funds. In addition, these funds are suitable if you have a short investment horizon.
Who Offers Short-Term Debt Funds?
Any private or government-owned fund house, rated under investment grade, can offer these funds.
Where Do Fund Houses Invest Short-Term Debt Funds?
The debt fund’s fund manager invests money in reliable companies that have a good record of repayment and an adequate cash flow from business operations. Money is invested in debt instruments and fixed-income securities like commercial papers, deposit certificates, government securities, and medium to long-term instruments.
How Do Short-Term Debt Funds Generate A Steady Income?
The manager will buy debt instruments, from money invested in the fund, at a specific interest rate. Every day, the interest income will be added to the debt fund. Consequently, the net asset value (NAV) of the fund will increase. Therefore, the amount of invested capital increases.
For example,
You invested Rs.100 at the interest rate of 12% annually. As per 1% monthly interest rate, your capital appreciates to Rs.101 after one month.
This debt funds generate a steady income by the accumulation of interest income and appreciation of the invested capital.
How are Short-Term Debt Funds as compared to bank Fixed Deposits?
The brief maturity period and security of investment make short-term debt funds a safe savings option comparable to Fixed Deposits (FD) offered by banks. However, these funds are a better investment than FDs.
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They give higher returns than FDs.
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They do not incur a penalty on closure before maturity if the predetermined period (usually five days to six months) is complete. However, the premature closure of FD confers a penalty of 1%.
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They are tax-efficient in comparison to FDs.
How Are Short-Term Debt Funds Taxed?
Capital gains (the difference between NAV at the time of purchase and sale) from a short-term debt fund are taxed as per your income tax slab. However, the dividend from such a fund is tax-free. The fund house will deduct a Dividend Distribution Tax (DDT) from your dividend payout. DDT is 28.84% that may offer a slight advantage in comparison to your tax slab.
What Are The Advantages Of Investing In Short-Term Debt Funds?
These funds offer numerous benefits:
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Safety of Investment: When the market interest rate increases, the NAV of a debt fund decreases, and vice versa. However, the impact of fluctuating interest rates on debt funds is minimal due to the short investment period. As a result, you earn stable and safe returns on your investment.
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Liquidity: Debt funds offer high liquidity. They can be easily converted into cash. These funds allow partial money withdrawal.
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Flexible Nature: You can exit debt funds whenever required, without the issuance of any penalty. This makes these funds more flexible than other mutual funds. They can serve as your emergency fund.
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Regular Income: If you opt to receive dividends from a debt fund, it can serve as your income at regular intervals.
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Balanced Portfolio: Investment in short-term debt funds, along with equity funds, brings a balance in your investment portfolio.
6.Tax Efficiency: Debt funds are more tax-efficient than the same kind of short-term investments. Also, note that TDS does not apply for these funds.
