Best Short Term Debt Funds in India

short term debt funds

Are you looking for the right investment option for short-term financial goals? Then, short-term debt funds are something you should think of. They offer a balance between returns and risk. 

Funds invested in debt securities for a short-period give you a stable income with limited exposure to interest rate volatility. 

In this blog, we’ll explore the best short-term debt funds, how they work, and important factors to consider when choosing one. 

What Are Short-Term Debt Funds?

A short-term debt fund is one of the categories of debt mutual funds, whose investment is done in short-term fixed-income securities such as governmental bonds, treasury bills, and corporate bonds that can pay out within 1 to 3 years. 

Investment in these funds gives one a bundle of benefits, the first being lesser interest rate as against the longer-duration debt funds. Short-term debt funds are ideal for conservative investors who might want to park their money in relatively safe instruments while wanting higher returns than a savings account or fixed deposit.

How Do Short-Term Debt Funds Work?

Fund managers invest in a diversified portfolio of debt instruments with short durations. The fund’s returns are generated primarily from the interest income earned on these underlying securities.

These funds gives you optimal balance between yield and safety, making them less sensitive to long-term interest rate movements. 

Best Short-Term Debt Funds

Now that we understand what short term debt funds are, let’s look at some of the best options available in the market. Here is a table listing some of the best short term debt funds with their respective assets under management (AUM), 3-year returns, and ratings:These funds are considered some of the best short term debt funds due to their strong track record of delivering consistent returns over the last few years. Choosing the right fund depends on your financial goals, risk tolerance, and investment horizon.

List of Top Short-Term Debt Funds

Fund Name

Fund Size (₹ Crs)

Return (p.a) (%)

Bank of India Short Term Income Fund

71

10.31

Shield Portfolio

8.04

Sundaram Short Duration Fund

194

7.98

UTI Short Duration Fund

2,567

7.79

ICICI Prudential Short Term Fund

19,746

7.46

Aditya Birla Sun Life Short Term Fund

8,760

7.29

Nippon India Short-term Fund

7,122

7.03

HDFC Short Term Debt Fund

14,622

7

Axis Short Duration Fund

9,342

6.92

Kotak Bond Short-term Fund

16,806

6.84

Baroda BNP Paribas Short Duration Fund

203

6.74

Tata Short Term Bond Fund

2,836

6.66

Mirae Asset Short Duration Fund

342

6.61

SBI Short Term Debt Fund

13,193

6.57

Bandhan Bond Fund Short Term Plan

9,329

6.55

DSP Short-term Fund

2,824

6.5

LIC MF Short Duration Fund

111

6.39

Invesco India Short Duration Fund

426

6.39

HSBC Short Duration Fund

3,761

6.3

 Source: Link

Ultra Short-Term Debt Funds vs. Short-Term Debt Funds

While discussing short term debt funds, it’s important to differentiate them from ultra short term debt funds. Both categories invest in debt securities, but ultra short term debt funds have an even shorter duration, typically ranging from 3 months to a year. This makes them less exposed to interest rate risk compared to short term debt funds, but they generally offer lower returns.

For investors looking for a slightly higher yield with minimal risk, ultra short term debt funds can be a good option. On the other hand, if you are comfortable with holding your investment for 1 to 3 years and can tolerate minor fluctuations in returns, short term debt funds offer better growth potential.

Tax on Short-Term Debt Funds

Understanding the tax implications of your investments is important for financial planning. The tax on short term debt funds depends on the duration of your holding. If you sell your investment before 3 years, the gains are considered short-term capital gains (STCG) and taxed according to your applicable income tax slab.

On the other hand, if you hold your investment for more than 3 years, the gains are classified as long-term capital gains (LTCG). 

It’s worth noting that the short term debt fund taxation can make these funds less tax-efficient compared to equity funds, but they remain a viable option for investors in higher tax brackets looking for stability and predictable income.

Factors to Consider When Investing in Short Term Debt Funds

Before diving into short term debt funds, it’s essential to consider a few key factors:

1. Risk Profile

While short-term debt funds are generally considered low-risk compared to equity funds or long-term debt funds, they are not completely risk-free. They can be subject to interest rate risk, credit risk, and liquidity risk. Therefore, assess your risk tolerance before choosing a fund. If you are extremely risk-averse, you might consider ultra short term debt funds instead, which have a shorter duration and are less exposed to interest rate movements.

2. Investment Horizon

These funds are suitable for investors with a short to medium-term investment horizon of 1 to 3 years. If your financial goals require liquidity or income within this timeframe, short term debt funds can provide a stable option. For even shorter horizons, consider ultra short term debt funds, which have a more liquid portfolio.

3. Expense Ratio

Another important factor is the expense ratio, which indicates the cost of managing the fund. A higher expense ratio can erode your returns over time, so it’s vital to compare the costs of different funds before making an investment decision.

Advantages of Short Term Debt Funds

1. Reduced Interest Rate Sensitivity

One of the key benefits of short term debt funds is their reduced sensitivity to changes in interest rates. Since these funds invest in debt securities with shorter maturities, they are less affected by rate fluctuations compared to long-term bond funds. This makes them a safer choice when interest rates are volatile.

2. Steady Returns

Investors seeking regular income will find short term debt funds appealing. The interest payments from the underlying securities provide a steady stream of income, which is distributed as dividends.

Risks of Short Term Debt Funds

1. Interest Rate Risk

While short term debt funds are less sensitive to interest rates compared to long-term funds, a huge spike in interest rates will not leave them safe from this risk. Rising interest rates can indeed invite unpredictability with respect to the fall in bond prices; therefore, your returns can also get affected.

2. Credit Risk

Short term debt funds can invest in lower-rated corporate bonds so that higher yields may be earned. This will expose the fund to credit risk, because there is a possibility of default by the issuer on interest or principal payments. Credit quality of the bond held in the fund should thus be checked before the investment.

Conclusion

If you are looking for stability, moderate returns, and lower interest rate risk, short-term debt funds are an ideal choice for a short to medium-term horizon. If you’re looking for better returns than savings accounts, and if you want to park funds for 1 to 3 years then these funds are ideal. 

Additionally, understanding the tax on short term debt funds ensures that you are fully aware of the tax implications, allowing you to make informed decisions.

By considering factors such as risk tolerance, investment horizon, and expense ratio, you can choose the best short term debt funds that align with your financial goals. For those looking for slightly less risk, ultra short term debt funds can offer an even safer option with relatively stable returns.

LenDenClub is India’s largest alternate investment platform which started operations in India in 2015. We have been helping investors diversify their investments beyond traditional investment instruments ever since.


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