Ultra Short, Low Duration and Money Market Funds

Debt funds are grouped mainly by how long their holdings last. From shortest to longest: overnight, liquid, ultra short, low duration, money market, short duration, and then medium and long duration.

The longer the holdings, the more the fund value can move when interest rates change. Our page on YTM and modified duration explains how to measure this.

These invest in debt and money market instruments with a portfolio duration of roughly three to six months.

They are slightly longer than liquid funds, so they can earn a little more in some conditions, with slightly more movement. They suit money you will need in the next several months.

Low duration funds hold instruments with a portfolio duration of roughly six to twelve months.

They are a step longer again. They suit money needed in about a year, where you can tolerate small movements in value in exchange for the chance of slightly better returns than very short funds.

Money market funds invest in money market instruments that mature within one year, such as treasury bills, commercial paper and certificates of deposit.

They are often of high credit quality and are close in behaviour to ultra short funds. The category name describes what they hold rather than a duration band.

A liquid fund holds instruments maturing within about three months, so it is steadier and usually quicker to redeem. These categories go a bit longer.

For money needed within weeks, a liquid or overnight fund is simpler. For money needed in six months to a year, many people consider ultra short, low duration or money market funds. Our page on arbitrage versus liquid funds covers another parking option.

People with a clear short-term goal, businesses parking surplus cash for a few months, and investors moving a lump sum into equity gradually. They are a practical middle step between a savings account and longer-term investing.

Some funds in these categories try to earn more by holding lower-rated bonds. That adds credit risk: the chance that a borrower delays or fails to pay.

In the past, a few such funds suffered sharp falls when a borrower defaulted. Always check the credit rating breakdown on the fact sheet. Our page on credit risk funds explains the warning signs.

Say you know a college fee is due in eight months. Keeping that money in a savings account earns little. Putting it in equity risks a fall right before the fee date.

An ultra short or low duration fund sits in between. The value moves only a little, and the money can be withdrawn a few days before the fee is due. That is the kind of job these funds are built for.

• Money set aside for a known expense six months to a year away, such as fees or a planned purchase.
• A lump sum waiting to move into equity through a transfer plan over several months.
• Part of an emergency buffer, once the most urgent part is in the bank or a liquid fund.

Our page on the systematic transfer plan explains how a parking fund feeds equity gradually.

They are not for money you might need tomorrow, since redemptions follow working days and cut-off times.

They are also not for long-term growth. Money kept in them for many years may not keep up with rising prices, as our page on inflation and your savings explains.

Because their holdings are short, these funds are only mildly affected when interest rates change. A rise in rates may cause a small dip; a fall may give a small boost.

They also reinvest quickly, so their yield tends to follow the general level of rates within months. Our page on YTM and modified duration explains how to see this sensitivity on a fact sheet.

Most funds in these categories have little or no exit load, but check the scheme documents. Redemption money usually reaches your bank within a working day or two.

Our page on the redemption process explains timelines.

Because returns in these categories are modest, the expense ratio takes a bigger share. Compare costs between funds and between direct and regular plans.

Our page on expense ratio explains how costs work.

For most people, the choice depends on the time frame. A few months: ultra short or money market. About a year: low duration.

Within a category, prefer good credit quality and a reasonable expense ratio over a slightly higher yield. A small extra yield is rarely worth a credit surprise.

These are debt funds for tax purposes, and the rules for debt funds have changed more than once. We do not quote rates.

Our page on mutual fund taxation covers the structure, and a tax adviser can confirm your situation.

• Ultra short: roughly three to six months.
• Low duration: roughly six to twelve months.
• Money market: instruments maturing within a year.
• Check credit quality and costs before choosing.

We are distributors rather than investment advisers and we recommend no schemes. If you want help deciding where money for the next year should sit, get in touch.