Finance

Everything You Need to Know About Short Term Debt Funds in India

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People who have never invested in mutual funds can attempt to do so by purchasing short term debt funds, often known as income funds.

The distinguishing characteristic of short-term debt funds is that, although being a mutual fund scheme, they have substantially shorter holding periods or maturities, which are often under three years. This is another distinguishing characteristic of these funds’ typical investment in debt instruments, including corporate, governmental, and bank papers like certificates of deposit.

However, one must learn everything there is to know about a given fund before placing any investments.

Who should invest in short-term income funds?

Short-term debt funds are ideal for people who:

– Are seeking cash returns for the short- to medium-term (between one and three years).

– Intentionally constructing a core debt portfolio with a short to the medium-term investment horizon.

– Attempting to allocate assets among different asset classes and is considering using this fund for their debt asset allocation.

Benefits of investing in short term debt funds

Balanced portfolio

A great substitute for balanced funds could be short-term debt funds. Equity and debt funds are combined in balanced funds. They include a risk component due to the equity component. So, investing in a balanced fund merely takes on more risk and raises your stock allocation.

The portfolio can be more evenly balanced by investing in short-term debt funds. These investments give the portfolio steadiness without the risk of stocks.

  1. Tax advantages

The fact that short-term debt funds provide higher tax benefits is another benefit of investing in them. Investors favour short-term debt funds over bank fixed deposits for this reason.

If held for more than three years, short-term debt funds are eligible for indexation. Such a feature is not offered in a bank FD. If you have a bank FD, you must pay the maximum tax rate if you are in the highest tax band. However, you can claim indexation and save taxes in a short-term bond fund.

  1. Flexibility

One of their main advantages is that short-term debt funds permit more flexibility. Investors can withdraw their money from the fund if they require money for an urgent need. Investors are not required to pay fees if they desire to withdraw their investment from the fund, unlike other mutual fund kinds.

Things to consider when you are planning to invest in Short Term Debt Funds

  1. Credit Rating

A bond is nothing more than a means of capital raising for businesses. Credit rating agencies assign a credit score to each bond or financial instrument. The following are India’s top three credit rating companies:

– Credit Rating Information Service of India Ltd (CRISIL)

– Credit Analysis and Research Ltd (CARE)

– Investment Information and Credit Rating Agency of India (ICRA)

After a thorough analysis of the bond or company, the issuer’s financial soundness, track record, etc., a credit rating is given. A bond with a AAA rating is considered to be reliable. A D rating, however, indicates that there are very likely to default.

  1. Modified Duration

This is an additional metric for determining a bond’s sensitivity to interest rate changes. The fund is more susceptible to changes in interest rates when the adjusted duration is high.

The adjusted length of short-term debt funds is two to three years. The modified duration of long-term debt funding is significantly longer.

  1. Average Maturity

The weighted average maturity of a fund’s underlying bonds and debt instruments is represented by this number. You may find out how long, on average, it took the underlying papers to mature. Short-term bond funds would have a lower average maturity, as expected. They become less susceptible to interest rate changes as a result. This occurs because interest rate fluctuations are significantly simpler to forecast for shorter durations.

Final Thoughts

While a portion of their corpus is allocated to longer-term securities, short-term debt funds invest primarily in short-term securities. Their interest rate risk is determined by how much debt has extended maturities exposed to it. They make money from their debt assets through interest income and capital gains.

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