What are Short Duration Funds – Definition, Advantages, Taxation

A short duration fund is an open-ended mutual fund scheme which invests in debt and money market instruments and has an investment duration of 1 year to 3 years. Considering the maturity period, these funds provide relatively low returns but also carry a low amount of risk.

What are Short Duration Funds?

Open-ended debt schemes that have short term Macaulay Duration of the fund i.e. between 1 to 3 years are called Short Term Duration Funds. Macaulay Duration means the time period in which the price of a bond will be repaid through cash flows. It is the duration after which an investor who invested in debt or bond securities will get back all his invested money through periodic principal repayments and interests on the same.

Thus, Macaulay Duration of a Debt Fund is calculated as the weighted average time period over which cash flows on its bond holdings in debt portfolio are received. If this duration is less than 5 years. Then these funds are known as Short Duration Funds.

Benefits of Investing in Short Duration Funds

• Less Risks

Unlike equity funds, they fluctuate less in a bear market and thus carry less risks and more stability

• Inflation Resistant

In comparison to long term funds, they are less sensitive to inflation. Bond funds interest rates do not change suddenly and thus once can go for short term investment

• Liquidity

They are highly liquid and easily convertible to cash, thus in times of emergency these bonds can be used for cash requirements

Who should Invest

• Investors with low risk tolerance should try investing in Short Duration Funds. They have lower risks than long term or intermediate bond schemes. New investors can try investing for short term in this fund
• Also, those investors who do not seek to go high risks of equity funds can go for this fund
• Investors seeking a better tax adjusted returns than a Fixed Deposit (FDs) can also invest in Short Duration Funds

Things to be considered before investing

Every investment requires a sufficient amount of research and valuation of factors such as risks involved, history of returns accrued, business proficiency of the holdings etc. Here are some of the things which must be considered by an investor before investing into the Mutual Funds:

1. Financial Goal– Before making any investment decisions, it is very important to evaluate that the fund objective is aligned to your financial goals
2. Fund Performance – Measuring the performance of the fund in both bullish and bearish market situations is a necessity as it helps the investors in selecting a reliable fund. One should always choose a fund which has been performing with consistency
3. Fund House & Management – There are numerous Mutual Funds regulated by different AMCs (Asset Management Companies). Fund houses & Fund Managers play a very decisive role in the allocation of assets and selection of stocks. If the management has enough experience and expertise, the fund will easily sail through promising market conditions and deliver good returns
4. Costs Involved – There are different costs involved in Mutual Fund investments such as Expense Ratio, Entry Load and Exit Load. Investors must review these costs before heading up for investments
5. Other Basics from the Portfolio – There are other different factors such as the fund NAV (Net Asset Value), AUM (Assets under Management) etc. which are to be viewed to make sure of the reliability and investor engagement in the fund

Best 10 Short Duration Funds to invest 

(Source: Value Research, based on 5 Year Returns)

Taxation

Short Duration Funds are counted as Debt Funds for tax purposes. If an investor has made a capital gain of ₹50000 on investment in a debt mutual fund and withdraws the amount before 3 years of investment, Short Term Capital Gains Tax would be levied, as per the income tax slab of the investor. ₹50,000 would be added to the taxable income of the investor and taxed accordingly.

If an investor withdraws the investment including capital gains post 3 years of investment, 20% Long Term Capital Gains Tax of 20% is levied, with the benefit of indexation.

Indexation reduces the value of overall Long Term Capital gains to reflect the effect of inflation on your investment.

To calculate the final value of capital gains post indexation, we use government’s Cost Inflation Index (CII) in the following formula:

Indexed cost of Acquisition = Investment Amount * (CII of the year of withdrawal/ CII of the year of investment)

Suppose the investment amount is ₹70,000 in the year 2016 and the withdrawal  amount is ₹1 Lakh. The value of capital gains is ₹30,000 before indexation

Indexed Cost of Acquisition = 70,000* (280/254) = 77,165.35

Note: CII in the year 2015 = 254

          CII in the year 2018 = 280

Final Value of Capital Gains= 1,00,000- 77,165.35 = 22834.65

Tax Payable = 20% of 22,834.65 = 4,566.93

Also know: Short Duration Funds vs Ultra Short Duration Funds vs Liquid Funds vs Fixed Income

How to Invest in Short Duration Funds

You can invest in mutual funds through either of the following ways-

• Offline mode of investing– If you are not confident of your knowledge, you may choose to invest through a broker. However, investing in a fund through a broker will make you eligible for investments through regular plans that offer different returns and varied expenses in investment. If you wish to invest in the fund independently, you must visit the nearest branch of the AMC of your fund. Don’t forget to carry the following documents-
  • Identity Proof (Aadhar Card)
  • Canceled cheque
  • Passport size photos (around 4-5)
  • PAN Card
  • KYC documents (for KYC verification)

• Online mode of investing– If you do not wish to add on to your expense of commissions or brokerage, you may visit online investment platforms such as Paisabazaar.com wherein you can choose from and compare more than 1,700 funds- all in one place, instead of following the long procedure of visiting the website of each AMC and then choosing from them. Here, you can select the fund in which you want to invest, look at the details and compare similar schemes as well as use SIP Calculator or Lumpsum Calculator to estimate the future value of your investment

For detailed information on how to invest in mutual funds, click here

Frequently Asked Questions

Q.1: How do I choose a good short-term Mutual Fund?

Ans: You can choose a good short-term mutual fund by analysing and understanding some of the key parameters-

1. First of all, be clear with your financial goals and your risk appetite
2. Pay attention to the historical returns to see how a fund has worked in the past. However, past performance of a fund is not entirely indicative of its future returns
3. Avoid the funds which have high turnover ratio
4. Look for the funds with professional management and best investing techniques such as diversification
5. Buy a no-load mutual fund and do not forget to pay attention to its expense ratio. ER must not be high

Q.2: Is SIP good for short term?

Ans: You can invest in an SIP for a short term but it is not entirely a good option. SIPs are essentially benefiting over long term periods. However, an intrinsically planned approach, favourable market conditions and good management may get you decent returns. If you are ready to bear the exit load and obvious risks which are associated with MF short-term investments, you can go for SIP. Otherwise, you can also invest in a Fixed Deposit or Recurring Deposit to enjoy safety of investments as well as steady returns.

Q.3: Which is the best short-term mutual fund?

Ans: There are a lot of short-duration mutual funds available from leading Asset Management Companies. Here are 5 best short term funds-

1. Franklin India Short Term Income Plan
2. Kotak Bond Short Term Plan
3. ICICI Prudential Short Term Fund
4. HDFC Short Term Debt Fund
5. IDFC Bond Fund

Q.4: Which is the best SIP for short-term mutual funds?

Ans: For short-term, Debt Funds are better for investments. Equity Mutual Funds have given great returns over long-term. You should also avoid investing in very aggressive funds and consider balanced advantages.