How to use short-term bond funds to your advantage?

Short-term bond funds invest in bonds for a shorter period of time i.e. less than five years. These generally invest in certificates of deposit, commercial paper etc.

Dec 10, 2017 09:12 IST India Infoline News Service

With so many options to invest in the stock market, different types of investments could be used to fulfill various requirements. One such mode of investment is a Short-term bond. These funds provide the safety of principal where the capital is preserved.

Let’s get into the basics of short-term bonds before getting to know its advantages.

What is a short-term bond fund?
Short-term bond funds invest in bonds for a shorter period of time i.e. less than five years. These generally invest in certificates of deposit, commercial paper etc. It has a lower interest rate risk as compared to intermediate and long-term bond funds due to a limited maturity period.

This investment is meant for investors who would not like to take risks with their capital and want to earn better tax-adjusted returns than fixed deposits.

How to use short-term bond funds to your advantage?
Short-term bond can be used as an investment to your advantage in the following way:
  • To park surplus funds which otherwise remains in current account: Often you end up with some surplus amount which you may not need in the coming short term. People generally tend to park these surplus funds in a current account or even in other short-term bank deposits. This kind of arrangements does not yield you any kind of good returns. So, it is better to park these surplus funds rather in such scheme where you get good yields on them. One such scheme is short-term bonds where you tend to get good yields for lower interest rate risk. While short-term bonds can be used to the best advantage for parking the surplus funds to earn good yields on them without much risk. Though it is not much popular among people it is definitely a much-sorted option to your advantage.
  • To accumulate and maintain emergency funds: It is very important to maintain emergency funds for those difficult days so that you do not resort to taking loans for your emergencies. Emergency funds can be accumulated by the contribution of a fixed small amount every month. But what is more important is to maintain it consistently and that requires a good sense of discipline. What if these funds are invested in a scheme where they tend to have good returns thereby increasing the funds on auto-pilot mode. Such a scheme where these funds could generate good returns without much risk on the interest rate is Short-term bonds. Thus, by parking your emergency funds in short-term bonds you will not only able to accumulate your funds but maintain them easily with higher returns.
  • To make annual/quarterly payments such as premiums, school fees, vacation etc.: Sometimes there are few payments or expenses which happen once or twice a year. For such expenses, one needs to be ready with the amount by the due date of payment. Simply parking this fund somewhere will not result in an optimum advantage in terms of yield. If these funds are parked in the short-term bonds then the returns on them are good with lesser risk. This way the funds kept for such payments could be paid on due dates but until then they help in yielding good returns with the help of short-term bond funds. While for quarterly payments you can opt for USTBs i.e. Ultra-Short-term Bonds which are a type of Short-term bonds but with a shorter duration of maturity.
  • To get higher returns despite inflation: When the inflation rises, the market tends to face interest rate risk especially when you choose long-term schemes. While the short-term bond funds tend to remain unaffected or least affected due to the shorter term the Net Asset Value (NAV) does not fluctuate dramatically. Thus, investing in short-term bonds tend to give higher returns despite rising inflation to your optimum advantage.
 
Conclusion:
Short-term bonds though not much popular among people are a very good option and prove themselves to be advantageous in terms of returns with lower interest rate risk involved. It proves advantageous to park surplus amount to get good yields with minimum risk involved.

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