I want some insights into short-duration funds. As the name suggests, these funds generally invest in the short-term paper that will mature in about 9-12 months. So, the investor has to come out of it within a short period of time and needs to pay short-term capital gains tax. Is there any harm if an investor stays invested for more than three years to get the benefit of indexation? In that case, is there any risk of erosion in the capital?
- Shankar
No, you don't have to necessarily get out of a short-duration fund as it is an open-ended fund which provides you with a mechanism to participate in it without any lock-in. When a fund claims to be investing in papers with a shorter duration of maturity, it basically signifies that the character of the fund will remain this, stating that its character will be less volatile and more predictable. Further, owing to the shorter maturity, the interest risk will be relatively lower than that of the funds with long- and medium-duration funds as well as dynamic bonds. Nevertheless, all such factors do not necessarily mean that you have to get out of the fund. Such factors just signify that you are investing in a less volatile fund but you can stay invested for three years.
In my opinion, an investor should invest in a short-duration fund with a time horizon of three years because the real charm of debt funds is the tax efficiency. When you hold a debt fund for three years, your gains are treated as long-term capital gains and it is taxed after indexation, which turns out to be very low taxation rate as compared to an interest income of similar kind derived from a bond or a deposit, which gets taxed at your marginal tax rate.
Also, if you have to pay taxes after holding your fixed-income fund investments after three years, then feel happy about it because you have beaten inflation.
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