Introduction 

Mutual Funds can seem complicated or intimidating to a lot of investors. A mutual fund is essentially the money pooled in by a large number of people or investors that is managed by a professional fund manager. It is a trust that collects money from a number of investors who share a common investment objective. Then, it invests the money in equities, bonds, money market instruments and/or other securities. Each investor owns units, which represent a portion of the holdings of the fund. 

The income/gains generated from this collective investment is distributed proportionately amongst the investors after deducting certain expenses, by calculating a scheme’s “Net Asset Value or NAV. A mutual fund holds a variety of investments which can make it easier for investors to diversify than through ownership of individual stocks or bonds.

Top Mutual Fund to Invest for 1 Year

Fund Name NAV 1 YR Return 3 YR Return
Mirae Asset Emerging Bluechip Fund Direct-Growth 59.87 18.67% 14.79%
SBI Magnum MultiCap Fund Direct-Growth 53.63 15.68% 11.27%
DSP Equity Opportunities Fund Direct Growth 243.59 15.07% 10.59%
SBI Bluechip Fund Direct-Growth 43.97 15.02% 10.39%
Motilal Oswal Multicap 35 Fund Direct-Growth 28.19 13.22% 10.43%
ICICI Prudential Bluechip Fund Direct-Growth 46.21 10.33% 12.01%
ICICI Prudential Equity & Debt Fund Direct-Growth 147.88 9.06% 10.75%
Aditya Birla Sun Life Tax Relief 96 Direct-Growth 33.68 8.18% 11.12%
L&T India Value Fund Direct-Growth 37.41 4.92% 7.44%
L&T Tax Advantage Fund Direct Growth 56.61 2.97% 9.08%

 

 

Returns of 1 Year Mutual Funds

The returns of liquid funds are close to those of fixed deposits of similar maturity. Note that FD returns may be higher for higher tenure FDs like 3 or 5 yr FDs, however, these are more comparable to short term debt funds than liquid funds.

Time Period 1 year 3 years 5 years 10 years
Avg. Category Returns 6.88% 6.94% 7.62% 7.65%

Tax on 1 Year Mutual Funds

The gains in liquid funds for a holding period of fewer than 3 years are characterised as Short-Term Capital Gains and taxed at respective slab rate. For example, if your slab rate is 30%. You invested Rs. 10 lakh in a liquid fund and sold it after 1 year at a NAV of Rs. 10.5 lakh. You have made a gain of Rs. 50,000 in the liquid fund investment and the same will be taxed at 30%. A tax of Rs 15,000 will be payable (along with any applicable surcharge/cess). 

Liquid Funds held for more than 3 years face Long Term Capital Gains Tax (LTCG) at 20%. You will also be given the benefit of indexation which accounts for inflation to reduce your tax burden. However, it is not generally advisable to invest in liquid funds if you have a time horizon of more than 3 years. For such a time horizon, you can look at short term debt funds.

Dividends on Liquid Funds are subject to Dividend Distribution Tax of 25%. Along with surcharge and cess, this tax becomes about 29%. It is deducted by the AMC at the time of declaring a dividend and hence the dividend itself is not taxable in the hands of the investor.

Reasons to Buy Short-term Mutual Fund Investments

  1. Diversification - When you buy a mutual fund, your money is combined with the money from other investors, and allows you to buy part of a pool of investments. Investors can diversify easily with the help of mutual funds as compared to ownership of individual stocks or bonds. Not all investments perform well at the same time. Holding a variety of investments may help offset the impact of poor performers while taking advantage of the earning potential of the rest. This is known as diversification.

  2. Professional Approach - You may not have the skills and knowledge to manage your own investments or want to spend the time. Mutual funds allow you to pool your money with other investors and leave the specific investment decisions to a portfolio manager. Portfolio managers decide where to invest the money in the fund, and when to buy and sell investments.

  3. Easy Buying and Selling - Mutual funds are widely available through banks, financial planning firms, investment firms, credit unions and trust companies. You can sell your fund units or shares at almost any time if you need to get access to your money. But you may get back less than you invested.

  4. Variety of Funds - Mutual funds can be used to meet a variety of financial goals. For example, A young investor with a stable income and many years to invest may feel comfortable taking more risk to achieve a greater potential return. They may invest in an equity fund. A mid-career investor trying to balance risk and return more moderately could invest in a balanced mutual fund that buys a mix of stocks and bonds.

Risks Associated with Short-term Mutual Fund Investments

  • Credit Risk - This risk is associated with a borrower defaulting on debt securities held by a liquid fund. IL&FS experienced default with AMCs like Principal AMC (Asset Management Company) which were hit the hardest. Similar instances in the past included a default by Amtek Auto, affecting the funds of JP Morgan AMC and JSPL affecting the funds of Franklin Templeton and other AMCs. However, such defaults are generally considered to be rare.

  • Interest Rate Risk - The prices of debt securities fall when interest rates rise and vice versa. This is termed as interest rate risk. Liquid Funds face an extremely low level of interest rate risk because the maturity of their holdings is very low. Short maturity debt is least affected by interest rates and vice versa.

End Note

If you have set an investment time horizon up to 1 year for yourself, you can invest in liquid mutual funds. This type of mutual fund invests in debt securities with a maturity up to 91 days. It allows the risk to remain at the minimum. It gives a return slightly more than fixed deposits of similar maturity. Liquid Funds are open-ended funds, meaning that you can invest in them and redeem your investments in them on any business day.