Including debt funds in your portfolio is a wise investment choice. Not only do they offer high liquidity and pose a lower risk, but they also yield high returns. Therefore they are better than bank deposits, whose interest rates often fail to beat inflation rates.
But what if your investment horizon is less than six months? Should you miss out on the benefits of debt funds? Not at all! You can invest in ultra short term debt funds.
What are Ultra Short Term Funds?
Ultra short duration funds are a type of debt fund. They invest in debt instruments like bonds, securities, and other money market instruments that offer capital appreciation.
The Securities and Exchange Board of India (SEBI) has classified debt funds into 16 categories. If your investment horizon happens to be less than six months, you can choose to invest in funds that come under the category ‘ultra short term mutual funds.
How do Ultra Short Term Funds work?
Ultra short term mutual funds have the same portfolio composition as debt funds. However, the Macaulay Duration of the fund’s portfolio is between three and six months. The Macaulay Duration is the weighted average number of years you must hold the bond until the present value of the bond’s cash flows equals the initial amount paid for the bond.
This means that the fund managers of ultra short duration mutual funds select money market instruments so that the fund achieves its objectives in three to six months.
Should You Invest in Ultra Short Funds?
You should invest in ultra short term funds if:
1) Your investment horizon is three to six months.
2) You want to invest in a low-risk instrument.
3) You do not want to invest in bank deposits or savings accounts
4) You need to achieve a financial goal within six months
Factors to consider before investing in Ultra Short Term Funds in India
#1 Understand the risks before investing
Like all debt funds, ultra short term funds are subject to credit risks (risk of the issuer defaulting) and liquidity risks (risk of the fund house not having enough liquidity for redeeming fund units.)
You can navigate credit risks by studying the fund’s portfolio and ensuring that all investments are made in high-rated securities. It is also important to research how competent the fund manager is.
#2 Chalk out an investment plan
Clearly define your investment goals. Then, you can look up the expected rates of returns to assess your expected gains. Usually, ultra short term mutual funds have returns ranging from 7% to 9%.