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Best short-term debt funds to include in investment plan in 2022

This article lists down the best short term debt funds for the year 2022.
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Mutual funds come with a broad spectrum of schemes that caters to every investor's needs based on their risk profile and investment objective. From long & short investment horizons to low, moderate, and high-risk profiles, there is something for everyone. Similarly, investors interested in shorter-term investments and looking for funds have the option of short-term debt funds, also known as Income funds. 

As the name suggests, short-term debt funds come with a smaller maturity period of 1 to 3 years. Here, most allocations are towards debt instruments such as government, corporate, and bank papers.

Best short-term debt funds in 2022

With a variety of funds available under the short-term debt investment, investors can choose funds depending on their choice and investment objective. The following table exhibits top-performing short-term debt funds and returns over time.

Scheme Name
Direct plan - Growth option
AUM(Rs. crores)1 year(Absolute return)3 years(CAGR)
HDFC Short Term Debt Fund14,331.653.04%7.14%
LIC MF Short Term Debt Fund219.722.29%5.90%
SBI Short Term Debt Fund12,073.753.01%6.52%
UTI-Short Term Income Fund - Direct2,450.928.07%5.19%
IDBI Short Term Bond Fund33.528.02%6.88%

Who should invest in short-term debt funds?

Short-term funds are suitable for investors having an investment horizon of one year to three years. Also, investors looking for low-risk investment routes to make decent tax-adjusted returns can choose to invest in these funds. These funds help investors preserve their capital investment while gaining a moderate yield. Moreover, short-term debt funds can generate better returns than bank fixed deposits, making them suitable for investors who want to build a debt-based fund portfolio. 

Taxation on gains from short terms debt funds

Short-term debt funds get taxed like other debt funds. The capital gains earned from these funds are taxed based on how long the investor holds fund units. Capital gain is the difference between the purchase and selling price of the units.

When an investor redeems the units before three years, the capital gains from the redemption/sale fall into the category of short-term gains and get taxed as per the investor's income tax slab rate. When the investor redeems the units after holding them for three years, the capital gains earned from them are considered a long-term gain and taxed at 20% with indexation benefit. Indexation benefit means the purchase prices are increased as per the inflation to calculate capital gains.

The risk associated with short-term debt funds

The short-term debt funds carry various risks and thus need investors' consideration.

  • Credit risk: Although short-term funds invest only in instruments with high credit ratings and have a proven track record, in some cases, the investor's fund portfolio may face credit risk. When a credit rating downgrades a security, its value decreases in the market, affecting the investor's portfolio. 
  • Interest rate risk: In this situation, the value of a bond or other fixed-income investment suffers because of a change in the interest rates. However, since these funds have a short maturity period, they have only a slight effect on their value because of interest rate changes.
  • Liquidity risk: Liquidity risk delays returns from investments. It occurs in such a situation when the sale unit volume is higher than the security buyers in the market. As a result, investors find it difficult to redeem their money. 

The returns potential of short-term debt funds 

Since the short-term debt funds come with a maximum three-year maturity period, they balance themselves well in fluctuating interest rates, thus offering greater certainty, lower volatility, and better returns. For selecting the best short-term debt funds, investors can check the return record of various funds over one year, two years, and three years. As such, a well-performing fund has the high potential to deliver a higher return than its benchmark and peer funds.

Advantages of short-term debt funds

The short-term debt funds offer a lot of benefits that investors can reap by investing in the funds.

  • Safe & stable returns: If you closely observe the debt market, you will notice an inverse relationship between debt and interest rates. So when there is a decrease in interest rates, the market value of debt increases and vice versa. As a result, most other funds get affected by changing interest rates when the market fluctuates but not short-term debt funds. Since these funds have shorter maturity periods, they are comparatively less susceptible to interest rate changes. They do suffer an effect, but it is marginal. As a result, short-term funds perform better than other funds and generate stable and safer returns on investment.
  • Flexibility: Short-term debt funds offer sufficient liquidity to investors to cash out their money more quickly than other investment options such as FDs, which come with a mandatory lock-in period. Debt funds act as emergency funds that can be dissolved easily in need of extra cash. Also, unlike other types of mutual funds, which may charge a fee as an exit load for withdrawal, investors do not have to pay additional charges if they wish to withdraw their investment from the fund before a fixed period. 
  • Taxation benefit: Profits earned from short-term debt funds from the holding period of more than a year attract lower tax when compared to bank deposits, especially for the investors who fall under the high-tax category.

Why should you invest in short-term debt funds? 

With short-term debt fund investment, investors enjoy a plethora of benefits such as stable returns, lower risk, and high liquidity. Furthermore, short-term debt funds have the potential to generate more returns than bank fixed deposits, and they are much more liquid. Another factor of these funds that score over bank deposits is that they attract lower taxes. Short-term debt funds tend to perform better in a falling interest rate scenario. As a result, they deliver significant returns to the investor. These funds are the best alternative for investors who want to get exposure to the mutual fund but don't want to bear the high risk of equity funds.

Conclusion

Short-term debt funds are ideal for investors who want to generate stable returns while minimizing their exposure to market risk. Investors can choose the best funds based on their financial goals and time horizon. If you are a new investor or don't know much about short-term debt fund investment, you can reach out to Glide Invest to get the assistance of expert financial advisors.

FAQs

Get all your queries answered related to short-term debt funds in this section.

  1. Are short-term debt funds safe to invest in?
    • Ans: Since these funds invest in top-rated companies with proven track records, they are much safer than other fund investments. However, they do have a fair share of risks involved.
  2. Do short-term debt funds come with a lock-in period? 
    • Ans: No. Short-term debt funds don't have a lock-in period, making it easier for investors to redeem their units if needed.
  3. Do short-term debt funds have an exit load?
    • Ans: Since there is no lock-in period in short-term funds, no exit load gets charged on the redemption of units. However, some funds may charge an exit load in case of early withdrawals. The exit load varies with the fund.
  4. Can I invest in a short-term debt fund through SIP?
    • Ans: Yes. You can invest in short-term debt funds through SIP.

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