Is it better to invest in short-duration debt funds instead of keeping money in a savings bank account? Why does the price of short-duration funds fluctuate on a daily basis when the instruments they invest in give fixed returns?
Bonds do give a fixed rate of interest but the point is that these bonds also trade in secondary markets where the prices are subject to the ups and downs of the market and that's why there are fluctuations in bond prices. Now for somebody who invests in a bond and holds it till maturity, these ups and downs in the interim are only notional. This is because irrespective of these market movements in the bond price, the investor would still continue to get the interest at a fixed rate and upon maturity, would get back the full principal amount. But since mutual funds have to declare an NAV on a daily basis which is marked to market, i.e, the bonds in the portfolio are valued at their market prices, there are ups and downs in the NAVs of the bond funds on a day-to-day basis. Even though these fluctuations are not of the magnitude that one sees in the equity markets, they are certainly there.
Coming to her question about the suitability of short-duration funds, I'll say yes if her investment horizon is not limited to the next few months, then short-duration funds should still be a good option. If you look at things from here on, there is a general expectation of a rise in bond yields. In fact, bond yields have already been on the rise since the start of the year and directionally they are expected to continue to move up from here on and that generally has a negative impact on bond funds. However, given that short-duration funds invest in bonds of fairly short maturity of about one to three years that is the kind of Macaulay duration these funds have to maintain, the impact of these interest-rate movements or the upward bias on yields on these funds is going to be limited and on top of it, they'll continue to earn from the interest income that they receive from the underlying bonds that they hold. So, I'd say that if your investment horizon is two years or upwards of that, then these funds should be fine.