Debt funds are considered safer for short-term investments because they remain unaffected by daily fluctuations in the equity markets.
Equity mutual funds are for long-term investments. For short-term investments, you should put your money in debt funds. Debt funds are further categorised on the basis of duration of the debt instruments in which they invest.
Debt funds are considered safer for short-term investments because they remain unaffected by daily fluctuations in the equity markets. However, debt funds are also subject to risks like interest rate risk, credit risk etc due to fluctuations in interest rates and trading of debt papers in secondary markets. Such risks increase with the duration of the debt papers that comprise the debt fund portfolio.
According to the duration of the debt instruments in which investments are made, debt funds are divided into several categories, like Overnight Fund, Liquid Fund, Ultra Short Duration Fund, Low Duration Fund, Money Market Fund, Short Duration Fund, Medium Duration Fund, Medium to Long Duration Fund, Long Duration Fund etc.
Liquid funds are one of the most popular funds for people want to put their money for short duration as such funds provide ready liquidity. The NAV of liquid funds are calculated even on weekends and any redemption requests put before 3 pm on any day, including Sunday, are obliged on the same day and the redemption amounts are credited into the bank accounts of the investors on the very next day. Moreover, liquid funds invest in debt and money market securities with maturity of up to 91 days only, making it less pron to fluctuations in interest rates and subsequent effect of the rate fluctuations on the value of the securities in the secondary markets.
However, following the negative impact on NAV of some liquid funds after the IL&FS fiasco, questions arise on safety of liquid funds, which puts money on debt instruments with maturity period of as low as 91 days or less. To counter the problem, the Securities and Exchange Board of India (SEBI) is encouraging the Overnight Funds, which put money in overnight securities having maturity of just one day. Although the rate of return on overnight securities may be lower than that of the instruments having 91-day duration, but overnight funds would provide better capital protection. This is because there will be almost no chance of any negative impact of interest rate fluctuations on overnight instruments.
As a result AMCs are coming up with funds in the overnight category for the risk-averse investors, for whom capital safety is prime even if it comes with a bit lower return.
However, other investors may consider IL&FS case as one off incident and continue to invest in debt instruments that suits their investment objectives.
Following table shows the categories of debt funds and the duration of instruments in which they invest.