You would find many mutual funds categorised under low-risk mutual funds. However, you will not find risk-free mutual funds. You may consider overnight funds, liquid funds, ultra-short duration funds, low duration funds and money market mutual funds as low-risk mutual funds.

1. Introduction to Low-Risk Mutual Funds

You may consider debt funds to be low-risk as compared to equity funds. However, debt funds may have credit risk and interest-rate risk. You could opt for debt funds with AAA-rated bonds and duration up to one year in the portfolio to reduce credit and interest-rate risk. You would find low-risk mutual funds with minimum risk, but offer a lower return than equity funds, medium to long duration funds, long duration funds and credit risk funds.

2. Top 10 Low-Risk Mutual Funds

The table below shows the top-performing low-risk mutual funds based on 3-year and 5-year returns:

 

Fund

3-Year Returns

5-Year Returns

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3. Who should invest in low-risk mutual funds?

You may consider investing in low-risk mutual funds if you are a conservative investor. It focuses on preserving capital and offering regular income. You have liquid funds, ultra-short duration funds and money market mutual funds which are low-risk mutual funds. Liquid funds put money in short-term securities such as treasury bills, commercial paper, deposit certificates, and other debt securities. It has a maturity period within 91 days and invests only in high liquidity and good credit quality. You may invest in liquid funds if you have an investment horizon of up to three months. Liquid funds offer a flexible holding period with an easy exit option as compared to bank fixed deposits. You could park your emergency corpus in a liquid fund. You could consider investing in ultra-short duration funds if you have an investment horizon of up to six months. It has a high degree of liquidity and offers a regular income. However, it’s riskier as compared to liquid funds. Ultra-short duration funds could offer a higher return as compared to bank fixed deposits. You may consider investing in money market funds if you have an investment horizon of up to one year. It invests in money market instruments that have a short tenure and are less vulnerable to interest rate risk. You can invest in money market funds if you want to preserve capital and earn a regular income.

4. Taxability of low-risk mutual funds

You would find low-risk funds such as liquid funds, money market funds and ultra-short duration funds taxed similarly to debt funds. You have short-term capital gains (after a holding period below three years) taxed according to your income tax slab. The long-term capital gains (after a holding period of three years or more) are taxed at 20% with the benefit of indexation. The indexation benefit increases the low-risk mutual fund’s purchase price, such as a liquid fund or ultra-short duration fund, to adjust for inflation. It helps you to reduce the long-term capital gain and save on taxes. The dividends you earn from low-risk mutual funds are added to your taxable income. You have to pay taxes depending on your income tax slab. You may earn a tax-efficient income compared to bank fixed deposits if you fall in the higher income tax slabs.

5. Risks associated with low-risk mutual funds

You have negligible credit risk and interest rate risk if you put money in low-risk mutual funds. It puts your money in AAA-rated bonds with high credit quality and bonds of duration under one year. However, low-risk funds are vulnerable to inflation risk. Inflation is the rise in prices of services and goods with time. Inflation risk means the money you receive from an investment loses value when adjusted for inflation. It is also called purchasing power risk. Inflation risk is the highest in fixed income instruments such as bonds, bank FDs and corporate fixed deposits. Investors are paid a fixed periodic interest, and the principal amount is returned on the maturity of the fixed income instrument. Inflation risk impacts low-risk mutual funds as it erodes the real value of the investment.

6. Things to consider before investing in low-risk mutual funds

  • Investment Objectives: You may invest in low-risk mutual funds to attain your short-term financial goals. It is ideal for creating an emergency fund to protect you during a financial crisis.
  • Time Horizon: You may invest in low-risk mutual funds if you have an investment horizon of under one year.
  • Risk Profile: Low-risk mutual funds are not impacted by credit risk and interest-rate risk. However, you have to be careful of inflation risk, which affects the return from your investment.
  • Track Record: You may diversify your portfolio with low-risk mutual funds. You must check the expense ratio, which is the cost of managing the fund. You may select the low-risk mutual fund after checking the track record over three years or more, and the performance of the scheme against a benchmark index.
  • Check the fund fact sheet: You could study the low-risk mutual fund portfolio from the mutual fund fact sheet. Check the credit rating and the duration of the bonds in the portfolio of the low-risk mutual fund.

7. Advantages of investing in low-risk mutual funds

The following are the benefits of investing in low-risk mutual funds:

  • You can put money in low-risk mutual funds to achieve your short-term financial goals.
  • It helps you get regular income and also protects your capital.
  • It is a tax-efficient investment compared to a bank fixed deposit if you fall in the higher income tax brackets.
  • You may get a higher return as compared to a bank fixed deposit.
  • You can liquidate your investment during a financial emergency.