Mutual investments are known for their benefits over a longer period. Many factors contribute to this, especially compounding. In investments, compounding is the idea that the profit you generate is invested back into the corpus and the compounded corpus starts to earn returns. Long-term investments sometimes also benefit from tax rebates.
But does that mean mutual fund investments are unsuitable for short-term investments? If it is a viable choice, how can it make a profit for you if there is no time for compounding to do its trick? Let us find out.
Mutual Funds For Short Term
There are two main things any investment option will focus on – capital appreciation and capital preservation. An investment can focus on either one of these or both of these.
An investment option with a long-term vision can focus on either or both.
For instance, an equity mutual fund can focus on capital appreciation, while a debt mutual fund will focus on capital preservation.
At the same time, if you want both preservation and appreciation, you could choose something like a balanced advantage fund, where the portfolio has securities and debts at similar levels to focus on balance.
But it comes to short-term options, choices become limited. Moreover, as discussed above, compounding is a huge factor in long-term mutual funds’ ability to appreciate your capital. This is because for compounding to work, the investments need to for a higher period. But short-term funds don’t have this luxury. Hence, most of them focus on capital preservation than appreciation. So if you aim to appreciate our capital, short-term mutual funds may not be able to achieve that.
But if your goal is capital preservation for a short period, short-term funds could just be the option you are looking for.
What are short-term mutual funds?
Short-term mutual funds are open-ended funds with a maturity period between 15 to 91 days. For this, they invest in securities that have similar maturity periods. Hence, the maturity period of the funds varies according to the maturity period of the securities they invest in.
Investments in these funds are focused on high-quality debt assets with a low level of risk, and the returns are based on interest returns. Hence, this fund makes it an excellent choice for investors with a lower risk appetite. In addition, this makes it a good investment option for people looking to park their money for a short period safely. But if you want to park your money for more than a few months, these investments may not be the best option as they may not even beat inflation.
Risks associated with short-term mutual funds
Short-term mutual funds rarely invest in market-linked securities. This factor makes it risk-free in terms of market volatilities. But that doesn’t mean they are entirely free of risks. Below are three risks you can expect to face when investing in a short-term mutual fund.
Higher liquidity ensures the easiness with which you can sell your units. However, short-term mutual funds are known to have liquidity risks.
Short-term mutual funds heavily invest in debt securities. Hence, there is a chance of credit risk arising from default payments.
Interest rate risk
Your returns from short-term funds are from interest payments. There is a chance of this interest changing due to various geopolitical situations.
Choosing a fund that matches your investment horizon is important in the case of short-term debt funds too. Hence, make sure you talk to an investment expert before investing.