These are the mutual fund schemes that select bonds or debt instruments for investment over a short-term. The average maturity period for such investments is short and thus it helps negate the interest rate fluctuations. However, they may provide lower returns than equities as they are low risk investment products.
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Investing in ultra-short funds is beneficial, only if you are keep the following things in mind:
The investors have to take care of the management fee of called the expense ratio. Since the SEBI has specified the upper limit of expense ratio to be 1.05%, the investors can recover and profit from the overall investments if they hold the funds for a long-term.
The price of these funds change on a regular basis and these are more volatile investments when compared to liquid funds. Thus you need to remain invested in ultra-short funds for a longer period to generate sufficient returns.
You can use this investment instrument to serve various financial goals. If you need an avenue to park your surplus funds for a short-period, then these funds may prove beneficial. You may also use these funds to create emergency funds or park a portion of your retirement corpus. You may also initiate a STP to equity funds by using ultra-short funds by investing a lump sum amount.
When assessed in terms of returns, the investor can expect returns within the range of 7% to 9%. These funds they do not offer guaranteed income and thus the total income you are about to receive at maturity cannot be estimated. These investments offer favorable returns when compared to other investment options like liquid funds. The NAV of the funds fluctuate with the change in the interest rates in the economy and thus investors can expect better yield during a falling interest rate regime.
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Tax implications are an important point investors must assess before investing. The investors are liable to pay taxes on such investments due to the capital gains. The rate of taxes imposed on your income depends on the tenure for which you remain invested. Since these are short-term investments, the STCG is added to the investor's net income and is taxed according to his income slab. For a holding period of more than 3 years, the investor's are taxed at the rate of 20% after indexation and at 10% without the benefit of indexation.
Ultra-short term funds are ideal for conservative debt investors who want to benefit from the changing interest rates. The debt funds do not carry much of investment risk and are somewhat immune to interest rate risk due to the short maturity periods of the underlying assets. However, when compared to liquid funds, ultra-short debt funds can be a little risky.
Moreover the investor may face credit risk due to the fund manager's decision to incorporate low credit rated securities in expectation of a better return in future. Additionally the introduction of government securities may introduce some market fluctuations to the fund, more than expected.
There are several reasons why you should invest in ultra-short term funds:
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