Best Mutual Funds For Short-Term Investment Goals

Mutual funds are a popular investment vehicle, offering diversification and professional management. When considering a very short-term investment horizon, such as one month, investors should be aware of the limited options available and the associated risks. While mutual funds can be a good investment option for longer-term financial goals, they may not be the best choice for extremely short-term investments. Here's why:

Limited Options: Most mutual funds are designed for long-term investing and typically have minimum holding periods or lock-in periods. For example, ultra-short-term mutual funds, which are suitable for short-term investors, usually have investment durations ranging from one month to 18 months.

Liquidity Risk: Mutual funds need to maintain sufficient liquidity to meet investor redemptions. During periods of high redemption requests, funds may struggle to sell their underlying assets quickly enough to meet these requests, potentially leading to a dip in returns.

Volatility and Risk: The stock market is inherently volatile, and short-term investments are more susceptible to the impact of market fluctuations. This volatility can significantly affect returns over a short time frame. Additionally, debt-oriented mutual funds, which are common choices for short-term investments, are sensitive to changes in interest rates, further adding to the risk.

Fees and Expenses: Mutual funds charge various fees, such as management fees (expense ratios) and potential entry and exit loads. These fees can eat into returns, especially for very short-term investments.

In conclusion, while mutual funds can be a good investment option for long-term financial goals, they may not be ideal for extremely short-term horizons like one month. Investors seeking a one-month investment option may want to consider alternative investment vehicles or strategies that are better suited for such short periods.

Ultra-short-term funds: Fixed-income debt fund schemes that invest in debt and money market assets for a week to 18 months

Ultra-short-term funds are fixed-income debt fund schemes that invest in debt and money market assets for a period of a week to 18 months. They are suitable for investors who are looking to stay invested for a short period of time, typically from 1 month to 18 months. These funds offer several benefits such as high liquidity, short-term goal fulfilment, and sufficient returns.

When compared to other short-term funds, such as liquid funds, ultra-short funds offer higher returns. However, it is important to note that they do not offer guaranteed returns, and the Net Asset Value (NAV) of the fund tends to fall with a rise in the overall interest rate in the economy. Hence, they are more suitable for a falling interest rate regime.

Ultra-short-term funds are also relatively immune to interest rate risks due to their short maturity and underlying assets. However, they are considered riskier than liquid funds. While the risk involved in these funds is generally low due to the short duration of the investment, there is still a possibility of default risk.

Some popular ultra-short-term funds in the Indian market include the UTI Ultra Short Duration Fund, Nippon India Ultra Short Duration Fund, Axis Ultra Short Term Fund, ICICI Prudential Ultra Short Term Fund, and Tata Ultra Short Term Fund. These funds have provided annualised returns ranging from 5.77% to 7.1% in the past three to five years.

Overall, ultra-short-term funds are a good option for investors seeking short-term investments, have a low-risk tolerance, and are looking for an alternate source of income with minimal market effects.

Short-term funds: Mutual funds that select bonds/debt for investment with an average maturity period of 1 to 3 years

Short-term funds, or ultra-short-term funds, are fixed-income debt fund schemes that invest in debt and money market assets for a period of one week to 18 months. These funds are suitable for investors who are looking to invest for a short period of time, typically from one month to three years.

When selecting a short-term fund, investors should consider the following:

• Risk: While these funds are less susceptible to interest rate risks due to their short maturity and underlying assets, they are riskier compared to liquid funds. Therefore, investors need to assess their risk appetite before investing.
• Return: Short-term funds generally offer higher returns compared to liquid funds. However, they do not offer guaranteed returns, and the net asset value (NAV) of the fund tends to decrease when there is a rise in interest rates in the economy. Hence, they are more suitable for a falling interest rate regime.
• Costs: Like any other mutual fund, ultra-short-term funds have an expense ratio. Therefore, investors should consider the overall returns generated by the fund, along with factors such as the holding period and expense ratio, to make an informed decision.
• Horizon: Ultra-short-term funds generate returns from the coupon of short-term underlying assets, which can be volatile. Hence, a short investment horizon may not be adequate to generate substantial returns.
• UTI Ultra Short Duration Fund (Lump sum: ₹500, SIP: ₹500)
• Nippon India Ultra Short Duration Fund (Lump sum: ₹100, SIP: ₹100)
• Axis Ultra Short Term Fund (Lump sum: ₹5,000, SIP: ₹1,000)
• ICICI Prudential Ultra Short Term Fund (Lump sum: ₹5,000, SIP: ₹1,000)
• Tata Ultra Short Term Fund (Lump sum: ₹5,000, SIP: ₹500)
• Mirae Asset Ultra Short Duration Fund (Lump sum: ₹5,000, SIP: ₹1,000)
• Mahindra Manulife Ultra Short Duration Fund (Lump sum: ₹1,000, SIP: ₹500)
• Baird Short-Term Bond (Expense Ratio: 0.55%, Effective Duration: 1.84 years)
• JPMorgan Limited Duration Bond ETF (Expense Ratio: 0.24%)
• PGIM Short-Duration Multisector Bond Fund/ETF (Expense Ratio: 0.40%, Effective Duration: 1.94 years)
• PGIM Short-Term Corporate Bond (Expense Ratio: 0.38%, Effective Duration: 2.66 years)
• Schwab Short-Term US Treasury ETF (Expense Ratio: 0.03%, Effective Duration: 1.89 years)
• SPDR Portfolio Short Term Treasury ETF (Expense Ratio: 0.03%, Effective Duration: 1.85 years)
• Vanguard Short-Term Corporate Bond (Expense Ratio: 0.05% (mutual fund), 0.04% (ETF), Effective Duration: 2.61 years)
• Vanguard Short-Term Treasury (Expense Ratio: 0.07% (mutual fund), 0.04% (ETF), Effective Duration: 1.88 years)

Money market funds: Fixed-income mutual funds that invest in top-quality, short-term debt

Money market funds are a type of mutual fund that invests in highly-rated, short-term debt securities. They generate income but little to no capital appreciation. Money market funds were established in the 1970s to provide a slightly higher-yielding alternative to interest-bearing bank accounts.

Money market funds are extremely low-risk investments with a typical par value of $1. They are considered one of the least volatile types of mutual fund investments. The funds are required by SEC regulation to invest in short-maturity, low-risk investments, making them less prone to market fluctuations than many other types of investments.

Money market funds tend to hold many different securities, with limited exposure outside U.S. Treasury funds to any single issuer. The funds are also very liquid; investors can buy and sell them with comparative ease.

However, money market funds have some disadvantages. Returns tend to be low, and there is a risk of losing purchasing power if the rate of inflation is higher than the fund's return. There is also no Federal Insurance Protection for money market funds, and they are not insured by the FDIC.

Arbitrage funds: Hybrid funds that leverage price differentials in cash and derivatives markets

Arbitrage funds are hybrid mutual funds that simultaneously buy and sell securities in different markets to take advantage of price differentials. They are suitable for investors who want to profit from volatile markets without taking on too much risk.

Arbitrage funds profit from price differentials in the cash and futures markets. They may purchase stock in the cash market and sell that interest in the futures market, as the most important types of arbitrage occur between these two markets. As a result, arbitrage funds execute a large number of trades each year to make substantial gains.

The cash market price of a stock (the spot price) is what most people equate with the stock market. For example, if the cash price of one share of ABC Company is $20, you can purchase a single share for that amount. Meanwhile, the futures market is slightly different as it is a derivatives market. Futures contracts are valued based on the anticipated price of the stock in the future, rather than the current price.

Index arbitrage is another popular type of arbitrage. In this case, an arbitrage fund might buy shares of an exchange-traded fund (ETF) that is selling for less than the value of the underlying stocks and immediately redeem the ETF for shares of stock to make a profit.

Overall, arbitrage funds are a good choice for cautious investors who want to benefit from volatile markets without exposing themselves to excessive risk. However, due to the high number of trades required, these funds can have high expense ratios, and their payoff can be unpredictable.

Liquid funds: Mutual funds ideal for short-term parking (up to one year) that invest in money market instruments maturing within 90 days

Liquid funds are a type of mutual fund that invests in short-term debt or money market instruments, typically with a maturity period of up to 91 days. These funds are ideal for investors who are looking for a safe and convenient way to park their money for a short period, ranging from a few days to a few months. Here are some key points about liquid funds:

• Low Risk: Liquid funds are considered one of the safest types of mutual funds due to their extremely short lending duration and high-quality borrowers. The near-zero risk of loss makes them suitable for investors who want to put money aside for emergencies.
• Returns: Liquid funds typically offer higher returns than savings bank accounts, with historical returns of up to 50-100% more. However, it's important to note that returns are not guaranteed and can be volatile due to changes in interest rates.
• Investment Horizon: Liquid funds are best suited for short-term investors with a horizon of up to one year. They are a good alternative for those who want higher returns than bank deposits but with minimal risk.
• Costs: Liquid funds have a management fee called the expense ratio, which needs to be considered before investing. The expense ratio for liquid funds should be comparatively low due to their short-holding period.
• Redemption: Liquid funds offer a fast redemption process, usually within one business day, and there is no exit load charged after the seventh day from the date of purchase.
• Taxation: Liquid funds are taxed differently depending on the holding period. If held for less than three years, the returns are taxed as short-term capital gains. If held for more than three years, they are taxed as long-term capital gains with the benefit of indexation.
• Risks: While liquid funds are low-risk, they are not risk-free. There is a chance of sudden drops in net asset value due to changes in the credit rating of the underlying funds and bonds. Additionally, liquid funds may not keep up with inflation, especially during periods of low-interest rates.

Overall, liquid funds are a good option for investors seeking a short-term, low-risk investment with higher returns than traditional bank deposits. However, it's important to consider the costs, potential risks, and taxation implications before investing.

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