1. What are Short-Term Bond Funds?
Short-term bond funds make investments in securities that have a maturity period between a year to three years and offer high liquidity. Apart from commercial papers and certificates of deposits these also invest in government securities and medium and long-term instruments. Any entity or fund house can issue short-term debt (bonds) including government, corporations for investment and companies rated below investment grade. These are also available in dividend and growth options.
2. Risk and Return
Short-term bonds funds have a low-interest rate risk as compared to an intermediate or a long-term bond. This allows them to hold together in adverse market conditions. The point to note is that an investor can lose the principal amount of their investment with short-term bond funds.
3. Who should invest in Short-Term Bond Funds?
This form of investment is ideal for investors who do not have a high-risk tolerance for their capital and seek to make tax-adjusted returns that are better than an FD. Some invest in high credit risk securities like high yield bonds, while others choose to invest in high-risk securities to compensate for the low yield environment. You must check the funds day to day fluctuations as compared to its peers before buying it. The fund may not as safe as its associate short-term bond fund if it has an above-average volatility.
4. Strategies for Investing in Short-term Bond Funds
Short-term bond funds offer investors a good investment option if investment prudently.
a) Short-term bond funds can maximize their gains by switching between investing in higher maturity debt scrips at one period of time, and then move to lower maturity scrips in another time period. When the interest is going down, the fund manager may buy longer tenured scrips when the interest rates are low and the bond prices go up.
b) Short-term bond funds are known to take a bit of credit risk. They have a considerable portion of their assets in high-quality AAA rated securities but they also invest a small fraction of their portfolio in some well-managed companies that have slightly weaker credit rated scrips. This poses a certain amount of risk in case the company defaults in interest or principal payments.
c) These funds use another strategy for the maintenance of their average maturities in a close range and for the confinement of the credit risk. This is a good way of creating long-term wealth as it avoids taking on excess risk and brings about a certain amount of stability to the portfolio.
5. Things to consider before investing in short-term bond funds
a) Expense Ratio
Understand the costs involved in investing in short-term bond funds. Since these funds are managed actively, there will be an added cost involved as compared to investing in a passively managed fund. Understand how much you would be paying in fee and extra cost before you invest.
b) Risk Tolerance
If you are averse to taking high risk and as an investor you are content with returns that aren’t too high, this may be the fund for you. Since the fund managers of short-term bond funds pick securities with high credit ratings, there is the least possibility if any of the issuers to default.
c) Tax Implications
It is vital to know your tax standing when investing in any fund. Short-term bond funds give out dividends at regular intervals which are taxed under the dividend distribution tax slab.
d) Investment Horizon
As an investor, you will not have to worry about the access to your funds being cut off for long as the ideal investment period for these funds spans between six months to a year.
e) Exit Load
Before investing in short-term bond funds, it is imperative for you to know that you may be charged an exit load if you choose to exit before the completion of six months or want to opt out of the scheme within a month of investing.
6. Advantages of Investing in short-term bond funds
a. Good and fixed returns in less period as compared to funds or investments which give mediocre returns, Example – Fixed deposit.
b. A lower degree of risk in bear markets.
c. Less sensitive to the inflation as compared to long-term bonds.
d. Highly liquid and easily convertible into cash.
e. Surplus funds can be invested in these bond funds rather than keeping it in the current account.
f. These funds can be a source of emergency funds as they are highly liquid
Short-term bond funds will not provide big or huge returns but can be used by investors who need safety for the invested amount & who are looking for a way to earn yields higher than those available on ultra-low risk investments. These funds are actively managed and can act as a very good investment return opportunity for people who are looking out for fixed returns.
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