Introduction
Short-duration funds, as the name suggests, are mutual funds that invest in short-term debt securities like bonds. The usual duration of the securities is 1 to 3 years. These funds are meant to be a safer investment option as compared to other debt funds because they reduce interest rate risks.
Interest rates and bond prices have a negative correlation, and as such, when interest rates rise, it decreases the price of a bond, and vice versa. Short-duration funds, with their short maturity periods, can reduce the effect of interest rate fluctuations on bonds.
What are the benefits of investing in short-duration funds?
While short duration funds aim to minimize interest rate risk, they still strive to generate higher yields compared to traditional money market funds or savings accounts. By investing in a diversified portfolio of fixed-income securities such as government bonds, corporate bonds, and money market instruments, these funds aim to capture higher income potential.
Short duration funds offer a variety of benefits which make them a more preferable over other money market funds. Some of the key benefits are discussed below.
- Low risk: Short duration funds invest in debt markets and hence are inherently less volatile in nature. Since their duration is comparatively shorter, it is not affected a lot by interest rate fluctuations.
- Steady streams of cash flow: These debt instruments usually provide coupon payments to investors on a regular basis, giving them a steady flow of cash. At maturity, they can also provide capital gains to investors.
- Short investment horizon: The short investment horizon of these funds provides high liquidity to the investors. Hence, they can get their money back within a short span of time.
- Diversification: Investing in short duration funds gives access to a large pool of debt securities in which the fund has a vested interest. This reduces the risk of losses even if any one of the debt instruments fails.
What are the risks pertaining to Short duration funds?
While short duration funds are a safe and sound option for investors, there still exists the credit risk for investors. Credit risk is the risk of default in case the borrower fails to repay the money within the specified timeframe.
This failure could either be due to lack of liquid cash or due to unwillingness to fulfill on its debt obligation, i.e. fraudulent practices. In either case, it poses a threat to the investor of losing the money. Hence, investors should carefully asses the funds before making an investment decision.
Conclusion
Short duration funds offer investors an attractive balance between stability and income potential. With their focus on shorter-maturity fixed-income securities, these funds provide a valuable investment avenue for all investors.
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