What do you look for, while shopping for a new gadget like a smartphone? You always try to get the best deal that gives you the best bang for your buck. You should have the same preference when choosing short term mutual funds.

You might have various financial goals of short-term (one to three years horizon), medium-term (three to five years horizon) and long-term (more than five years horizon). And there are hundreds of mutual fund schemes suitable for each goal. 

Now, if you are thinking about which mutual fund is best for the short term, then you will find your answer through this blog. 

Let us first understand short-term mutual funds.

What is a short-term mutual fund? 

Short-term mutual funds essentially invest in debt securities. As per the mutual fund type based on their underlying assets, they are called debt mutual funds. 

Short-term mutual funds can have a maturity period of around one to three years. If the investment horizon for your goal is shorter than a year, you can choose ultra-short debt funds or small duration funds. 

Why should you invest in short-term mutual funds? 

You can invest in short-term mutual funds for low-risk and stable returns to fulfil your various short-term goals. A few examples of short-term goals are:

• Tax planning.
• Home renovation.
• Paying school fees for your children.
• Going for a domestic vacation and more. 

Mutual fund houses offer different fund choices suitable for different goal horizons. For example, short-term or ultra-short debt funds are for short-term goals, hybrid and index funds are for medium-term goals, and diversified equity funds are for long-term goals. 

Why are debt mutual funds better for your short-term goals? 

Investing in equity mutual funds can be risky in the short term because the prices of equities fluctuate more often during this period. Therefore, you might also get negative returns while redeeming your equity mutual funds in a short span of one to three years. 

Debt mutual funds with lower maturity periods can be better for your short-term goals because they can offer stable and predictable returns. Therefore, investing in debt-based mutual funds can be less risky than investing in equity mutual funds for a short-term horizon.

How to choose the best short-term mutual funds? 

Select a maturity period that matches your goal horizon

If you sit down to consider all the debt mutual fund schemes available, you’ll probably end up with a list that’s too long to handle.

Rather than checking all the debt mutual fund schemes, you can focus on those mutual funds whose investment horizon matches your goals. 

Say you wish to renovate your house 12 to 15 months from now. For such a goal, you can choose debt mutual funds that have a maturity period of 12 months. 

Look at the qualifications of the fund manager

Each mutual fund is managed by a fund manager or a team of fund managers. The mutual fund scheme’s performance depends on the decisions made by the fund manager. 

Therefore, it is important to look at the educational profile and experience of the fund manager of short-term mutual fund schemes. You can also check other funds managed by the same fund manager and analyse their performance.

Check where the scheme is investing

The types of debt securities that a short-term mutual fund invests in can determine the degree of risk and return from the fund. 

For example, returns on corporate bonds can be higher than on government bonds. However, the degree of risk in government bonds is comparatively lower than the corporate bonds. 

Apart from the type of bonds, you can look for investments that popular credit rating agencies highly rate. These ratings represent the safety of your principal investment in the scheme. The higher the credit rating, the lower your investment risk. 

Compare the expense ratios

To manage mutual fund schemes, the fund houses charge a fee. This fee is called the Total Expense Ratio (TER) of a mutual fund. 

This expense is measured in terms of a percentage. The higher the TER percentage, the more amount is settled against your returns. 

Therefore, comparing the TER of similar mutual fund schemes from different fund houses is better before selecting the best short-term mutual funds for your goals. 

Check if there are any exit loads

If you redeem your mutual funds before their maturity date, mutual funds charge you a penalty. This penalty is called the exit load of a mutual fund scheme. 

Before investing in a mutual fund scheme, it can be better to check if there is an exit load on early redemption. With lesser or no exit loads on your investments, you can get more flexibility for your short-term financial goals.

If you follow the above mentioned points, you can get more benefits from your short-term mutual fund investments. But then, what are these benefits? 

What are the benefits of investing in short-term mutual funds?

Indexation benefits 

You can reduce the tax implication on your debt mutual fund investment with the help of indexation. However, you need to invest for three years in a short-term debt mutual fund to get the indexation benefit. 

Here is how indexation works: Your capital gains for a debt mutual fund are the redemption price of your fund units minus the indexed acquisition cost. The indexed acquisition cost of a mutual fund scheme means its cost concerning the rate of inflation. 

Indexation means readjustment. Therefore, your taxable capital gain declines when you divide your redemption price with the readjusted inflation rate. 

Portfolio diversification

Your portfolio can be better guarded against uncertainties if your investments are diversified. To diversify, you can invest in different securities like debt, equities and gold. Further, you can diversify your investments better if you divide them into financial goals of different horizons. Thus, investing in short-term debt funds can be better for short-term goals. 

Stable short-term returns

Short-term mutual funds have a lower risk profile than equity-based mutual funds. These funds can offer stable and low-risk short-term returns, thus adding stability to your portfolio. 

SIP and lump sum investments

You can invest bit-by-bit in a short-term mutual fund through Systematic Investment Plans (SIPs) or by investing in lump sum. While regular SIPs can help you inculcate the habit of savings, the lump sum option can allow you to park your excess money in mutual funds. You can even combine lump sum investments with your regular SIPs while investing in short-term debt mutual funds. 

In a nutshell

To select the best short-term mutual funds, you can look for the fund's management and underlying debt investments and compare their TER and exit loads on early redemption. You can also check if the maturity period of investing in the short-term mutual funds matches your goal's tenure. 

Investing in short-term mutual funds can get benefits like indexation, diversification and low risk or stable short-term returns. These benefits make short-term mutual funds more attractive for your short-term financial goals. 

Frequently asked questions

1) Which SIP is best for the short term?

A Systematic Investment Plan (SIP) in a short-term debt mutual fund can be better for reaching short-term financial goals. 

You can choose the best SIP for the short term by shortlisting mutual fund schemes based on their fund management, expense ratios, exit loads and the underlying investments. 

You can make a more informed decision by considering these factors and choosing a short-term mutual fund whose investment tenure matches your goal horizon. 

2)Which mutual fund is best for three months?

Ultra-short debt mutual funds and liquid funds are a better option if you are looking to invest for a short duration of three months. 

The ultra-short mutual funds can be redeemed after three months, whereas a liquid mutual fund can be redeemed at any time.