Ultra-short term debt mutual funds are money market mutual funds. Money market mutual funds invest in money market instruments like commercial papers, certificates of deposits, treasury bills etc. Money market instruments usually have very short maturity periods (less than a year). The two important characteristics of money market mutual funds are high liquidity and low risk. Ultra-short term debt funds invest in money market instruments whose residual maturities range from 91 days to 365 days. Ultra-short term debt mutual funds are similar to liquid mutual funds in terms of liquidity and risk (safety), but these mutual funds usually give higher returns than liquid mutual funds.
Ultra short term debt funds offer high degree of liquidity and safety for investors. Many ultra short term debt funds have no exit loads, but some schemes may levy exit loads for redemptions made within a specified period (usually a few days) from the investment date. Like liquid mutual funds, these funds have low interest rate risk and hence these funds offer a high degree of safety. It is very rare for ultra short term debt fund’s Net Asset Values (NAVs) to fall on a week on week basis. However, investors should note that ultra-short term debt funds can be slightly more volatile than liquid mutual funds over a period of few days or weeks. Therefore, investors should be prepared to remain invested in these funds for a few months (at least 3 months) to get good stable returns.
Ultra-short term debt mutual funds usually give higher returns than liquid mutual funds and so, if you do not need immediate liquidity (say within 3 months or so from the investment date), you should invest in ultra-short term debt funds. Even small differences in returns can result in a significant difference in rupees terms.
For example, if you have a Rs 50 lakhs lying in your savings bank account paying you 4% interest per annum for two months, you could have earned almost Rs 1 lakh more in nine months by parking the money in ultra-short term debt funds, assuming that ultra-short terms debt fund returns are 7% per annum. Sometimes the difference between the liquid fund returns and savings bank interest can be as high as 400 to 500 basis points (4 to 5 percentage points) or even more; the financial impact in such situations is much more.
For the same reason, for slightly longer duration very short term investments, you should select ultra-short term debt mutual funds over liquid funds. If ultra-short term debt funds give 0.5 to 0.75% higher returns than liquid funds, then on an Rs 50 lakh investment, you can earn Rs 25,000 to Rs 75,000 more in a year, by investing in ultra-short term debt funds instead of liquid funds.
If ultra-short term debt funds returns are taxed as non-equity funds. Profits from If ultra-short term debt funds held for a period of less than 3 years are as taxed as per the income tax slab of the investor. Profits from ultra-short term debt funds held for a period of more than 3 years are taxed at 20% after allowing for indexation benefits. Investors can also opt for dividends (daily, monthly etc) in If ultra-short term debt funds. Dividends paid by If ultra-short term debt funds are tax free in the hands of the investors, but the fund house has to pay dividend distribution tax at the rate of 28.8% which is deducted from the dividend paid out to the investors. Unlike savings bank or fixed deposit interest, no tax is deducted at source on ultra-short term debt fund returns for resident Indian investors.
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