For financial goals of up to 3 years like saving for holiday or creating an emergency corpus, short duration fund is an ideal fit.
What are short duration funds?
These are open-ended debt schemes that invest in instruments with a Macaulay duration of one to three years. These schemes generally invest in very low risk instruments like commercial papers, certificate of deposits and government bonds.
Advantages of short duration funds?
Low risk: The interest and credit risks are on the lower side as they hold short-term securities which are generally of the highest quality. However, some fund managers do take some risk by investing a portion in lower-rated papers.
Predictable return: The returns generated by short duration fund is generally steady as investment in shorter duration instruments saves them from high volatility.
Beyond these two advantages, short duration funds also offer high liquidity. Investors can also save on taxes if they remain invested for over 3 years.
Who should invest?
As the name suggests, short duration funds are meant for short term investments, i.e., 1-3 years. The reason why short duration funds are the top recommendation for this time horizon is because it carries lower risk as compared to most debt funds categories.
"The sweet spot from the goal perspective is 2-2.5 years. From the taxation point of view, 3 years is better but not all investors might agree to wait for that long," said Rahul Jain, Senior VP Research at International Money Matters.
In addition, considering low volatility and predictability of returns, investors can invest in short duration funds to generate regular income.
If a client is investing in mutual funds for the first time and is averse to risks then also short duration funds can be a good option especially if the client can remain invested for a minimum of 3 years. This is because of low risks and tax benefits.
Investors looking to park a lumpsum amount for doing STP in equity funds can also look at this category.
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