We need not emphasize the kind of investment opportunities one can explore with mutual funds. Investors with short term investment horizon and a low to moderate risk appetite can consider investing in short term debt mutual funds. SEBI also calls short term debt mutual funds income funds. Since these are short term debt funds, they have a much lesser maturity period, and the underlying securities in their portfolio mature in a short duration. The average portfolio maturity of a short duration fund can be up to three years or lower. A short term debt mutual fund predominantly invests in debt instruments like commercial papers, government bonds, bank papers, certificates of deposits, etc.
Investors must understand that they need to understand all the aspects of an investment scheme before investing. Let us understand short term debt funds in detail to determine if they are ideal for your financial goals.
Stability in a portfolio and returns
Since short term debt funds invest in a portfolio of debt instruments that mature over the short period, they are less likely to face any interest rate risk. Since these funds are not sensitive to changes in the interest rate, they have the potential to generate stable returns. Any changes in the market may have insignificant effect on the performance of a short term debt fund. Other debt funds that have a longer maturity period may not be able to offer stable returns like short term debt funds. Since they have lower sensitivity to fluctuating interest rates, short term debt funds might be able to generate stable returns.
High liquidity and flexibility
Debt mutual funds are best suited for investors who want to bring in some liquidity to their portfolios. Because of their flexible nature, investors can enter or exit short term debt funds at any given time. In the case of financial exigency, the investor can immediately withdraw from their short term debt fund investments, and the money is transferred to their registered savings account soon. Since there is no exit load, investors do not have to pay any charges for selling their short term debt fund investments.
Things to consider before investing
Although short term debt funds have a low maturity period and are highly flexible in nature, that does not make them an entirely risk free investment. Here are a few things that investors must take into consideration before investing in short term debt funds.
Only for short term investors – Only investors with a short term investment horizon of two to three years should consider investing in short term debt funds because the average maturity of the portfolio is short. These funds are designed to produce stable returns over the short run. If you seek inflation adjusted returns then you can consider debt funds with a longer maturity period.
Credit rate risk – A portfolio with short term maturity may not attract interest rate risk, but investors must ensure that their underlying securities of the portfolio have high credit ratings. Failing to do so may invite the credit rate risk, something which occurs when the bond issuers fail to pay the loan sum on the predefined date.