Best Mutual Funds For Short-Term Investments

Short-term mutual funds are a great option for investors who want to invest their money and expect to receive it back within three years. These funds are ideal for those who need to invest money for short-term goals or want to keep their money liquid. They are also a good choice for those who want to invest for a short period, typically from one month to 18 months, and are looking for an alternative to bank deposits. Short-term mutual funds are debt funds that lend to companies for a period of 1 to 3 years, mostly taking exposure only in quality companies with proven records of repaying their loans on time. They are not as risky as equity funds and are a good option for first-time investors.

Ultra-short-term funds

Some of the best ultra-short-term funds include:

• UTI Ultra Short Duration Fund
• Nippon India Ultra Short Duration Fund
• ICICI Prudential Ultra Short Term Fund
• Tata Ultra Short Term Fund
• Mirae Asset Ultra Short Duration Fund
• Mahindra Manulife Ultra Short Duration Fund
• IDBI Ultra Short Term Fund
• Baroda BNP Paribas Ultra Short Duration Fund
• DSP Ultra Short Fund
• Mahindra Manulife Low Duration Fund
• HDFC Ultra Short Term Fund
• PGIM India Ultra Short Duration Fund
• HSBC Ultra Short Duration Fund

When investing in ultra-short-term funds, it is important to consider the following factors:

• Risk: While these funds are immune to interest rate risks due to their short maturity and underlying assets, they are riskier than liquid funds.
• Return: These funds offer higher returns compared to liquid funds but do not offer guaranteed returns.
• Costs: Ultra-short-term funds have an expense ratio, so it is important to consider the overall returns generated by the funds.
• Horizon: These funds earn from the coupon of short-term underlying assets, so a short investment horizon may not generate sufficient returns.

Short-term debt funds

Some examples of short-term debt funds include the SPDR Portfolio Short-Term Corporate Bond ETF, iShares 1-5 Year Investment Grade Corporate Bond ETF, and the Schwab 1-5 Year Corporate Bond ETF. These funds offer exposure to corporate bonds with maturities of one to five years and have low expense ratios, which is beneficial for investors.

When considering short-term debt funds, it is important to remember that they are not risk-free. While they are safer than investing in high-yield bonds or the stock market, there is still a possibility of capital losses if interest rates rise. Therefore, short-term debt funds are usually recommended for investors willing to stay invested for at least a year, with a horizon of 1-3 years being ideal to optimise returns and minimise potential losses.

Low-risk, high-quality securities

Short-term mutual funds are debt funds that invest in high-quality, low-risk securities such as government securities, treasury bills, corporate bonds, and money market instruments. These funds have a shorter investment horizon than other categories of mutual funds, making them a convenient option for investors who want to invest for a short duration.

Some of the best short-term mutual funds include:

• Aditya Birla Sun Life Savings Fund (G)
• Kotak Savings Fund (G)
• ICICI Prudential Ultra Short Term Fund (G)
• SBI Magnum Ultra Short Duration Fund (G)
• HDFC Short Term Debt Fund (G)
• SBI Short Term Debt Fund (G)
• Nippon India Short Term Fund (G)
• Kotak Bond Short Term Plan (G)

These funds offer stable and good returns, diversification, and a regular flow of income. They are also more tax-efficient than bank fixed deposits or traditional bank accounts.

Short-term investment horizon

Short-term mutual funds are ideal for investors with a short-term investment horizon, typically between one and three years. These funds are suitable for those who want to invest their money and expect to receive it back within three years. They are also a good option for those who want to keep their money liquid.

Short-term mutual funds typically hold stocks with an average holding period of one year or less and have low turnover rates, meaning they don't buy and sell securities too frequently. This helps to minimise transaction costs while generating higher returns than longer-term funds.

Short-term mutual funds can be further categorised into ultra-short-term funds, liquid funds, and short-term debt funds. Here's a breakdown of each:

• Ultra-short-term funds: These funds invest in debt and money market assets for a period of a week to 18 months. They are suitable for investors with a very short investment horizon and offer the benefit of high liquidity. Examples include UTI Ultra Short Duration Fund, Nippon India Ultra Short Duration Fund, and ICICI Prudential Ultra Short Term Fund.
• Liquid funds: Liquid funds are one of the most popular short-term investment options. They invest in short-term debt instruments such as government bonds, corporate bonds, and commercial papers. Liquid funds offer high liquidity, low risk, and relatively high returns.
• Short-term debt funds: These funds invest in debt instruments with an average maturity of less than one year. They are not as liquid as liquid funds but offer slightly higher returns than ultra-short-term funds. Examples include Franklin India Short-Term Income Plan, Edelweiss Banking and PSU Debt Fund, and Nippon India Short-Term Fund.

When choosing a short-term mutual fund, it's important to consider factors such as return on investment, risk tolerance, investment horizon, liquidity, taxes, and inflation rates. Additionally, investors should look for funds with low fees and a diverse range of underlying assets to weather economic downturns better.

Short-term vs long-term returns

When deciding between short-term and long-term mutual funds, it is essential to consider your financial goals, risk tolerance, and investment timeframe. Here is a detailed comparison to help you make an informed decision:

Short-Term Mutual Funds:

Short-term mutual funds are ideal for investors who want quick returns or have immediate liquidity needs. These funds typically have investment durations ranging from a few months to a few years and are less affected by interest rate changes. They are generally lower risk and may include assets like money market funds or short-duration bond funds.

Benefits of Short-Term Mutual Funds:

• Liquidity: Short-term funds offer high liquidity, allowing investors to access their funds without incurring substantial penalties, making them suitable for emergency expenses or short-term goals.
• Lower Volatility: Compared to long-term funds, short-term funds exhibit lower volatility, making them attractive to risk-averse investors or those with short-term financial objectives seeking stable investments.
• Flexibility: Investors can reallocate their investments to seize new opportunities without long-term commitments, providing agility to adapt to changing market conditions or investment strategies.
• Potential for Higher Yields: Despite the lower risk, short-term funds can yield attractive returns compared to traditional savings accounts or certificates of deposit, offering investors higher potential returns with a degree of security.

Things to Consider:

• Interest Rate Risk: While short-term funds are less susceptible to interest rate changes, unexpected fluctuations can still impact fund prices significantly.
• Taxation: Short-term funds are taxed differently for equity and debt funds. For equity funds, investments held for up to 1 year are taxed as short-term capital gains (15% tax on profits). For debt funds, investments held for up to 3 years are taxed as short-term capital gains, based on the investor's income tax slab.

Long-Term Mutual Funds:

Long-term mutual funds are suitable for investors with a more extended investment horizon, typically spanning several years or decades. These funds focus on wealth accumulation and offer higher growth potential but come with greater market volatility. They commonly invest in equities, balanced funds, or diversified portfolios.

Benefits of Long-Term Mutual Funds:

• Compounding: Long-term funds harness the power of compounding, reinvesting returns to achieve exponential growth over time.
• Lower Transaction Costs: Long-term funds have lower turnover ratios, resulting in reduced expenses associated with frequent trading, benefiting investors in the long run.
• Reduced Tax Liability: Holding investments for more than a year often leads to favourable tax treatment, potentially resulting in lower capital gains taxes compared to short-term funds.
• Riding Out Market Cycles: Long-term investments allow investors to weather market volatility and benefit from overall market growth, maximising returns over time.

Things to Consider:

• Higher Risk: Long-term funds, especially those investing in equities, are inherently riskier due to market fluctuations.
• Time Horizon: Long-term funds require a longer investment horizon, typically several years or decades, to achieve their wealth accumulation goals.
• Sensitivity to Interest Rates: Long-term funds, especially those investing in bonds with longer maturities, are more sensitive to interest rate changes, which can impact fund values.

The choice between short-term and long-term mutual funds depends on your financial goals and risk appetite. Short-term funds offer liquidity, lower volatility, and the potential for quick returns, making them suitable for immediate financial needs. On the other hand, long-term funds provide higher growth potential and the benefits of compounding but require a longer investment horizon and carry higher risk.

Frequently asked questions