Short term debt funds invest in securities with tenors of one-three years. On account of the short tenure to maturity, risk of significant changes in the value of the securities due to interest changes.
They can invest in a mix of short-term instruments like commercial paper, certificates of deposits to medium- and longer-term instruments corporate debt scrips and government securities.
These funds are a better alternative to Bank Fixed Deposits in terms of liquidity, returns and taxation. Due to low maturity periods, risk of principal erosion is almost negligible and active portfolio management helps to deliver better returns than fixed income instruments.
When the interest rates are on a downward trend, the securities prices will rise to reflect the lower yield. Conversely, when the interest rates are on an upward trend, the prices will fall to deliver the higher yield indicated by higher interest rates
Short-term debt funds are best suited for an investment timeline of 1-3 years. For investing for a timeframe within 1 year, ultra-short-term debt funds are better suited.
Taxation on debt funds when gains are realized within 3 years of an investment, are taxed per the investor’s tax slab and after 3 years, the gains are treated as long term capital gains, and are taxed at 20% with benefits of cost indexation. In a bank FD, the taxation on interest is per the investor’s tax slab irrespective of time horizon of the investment and is required to be paid annually even if the FD is not matured. In case of debt fund, the tax is payable only when it is redeemed either partially or fully.
There is an exit load charged in short term debt funds, at the time of redemption ranging from 0.25% to 1% if redeemed within a period of 15 days to 6 months. Bank FD’s are penalized 1% if redeemed before maturity date.
With the Moody’s rating upgrade, is it a good time to invest in debt funds?
One of the biggest news for the Indian economy in recent times besides the demonization and GST implementation was Moody’s, the rating agency, upgrade of India’s credit rating from Baa3 to Baa2. With a better credit rating, the government securities become less risky reducing the bond yield, hence increasing the returns on bonds. But due to inflation the yield has stayed at almost the same levels as before the rating upgrade i.e. 7% and higher. As such, no significant upside is seen in the securities prices. Next indicator for bonds pricing would be the monetary policy to be announced by RBI in December 2017.
For an investment time frame of 1-3 years, short-term debt funds are still a better alternative to bank fixed deposits. It would be advisable to consult your independent financial advisor to seek the best course of action.