Short duration funds are a type of debt fund that mainly purchase debt and money market instruments. These can include government securities, corporate bonds and other fixed-income instruments. The main difference with these funds is the duration.

Under SEBI's rules, a short duration fund must maintain a Macaulay duration of 1 to 3 years. Macaulay duration is the time it takes for the bonds to pay back the initial investment.

These schemes sit somewhere in the middle of the short-term debt fund range. They generally carry more interest-rate risk than low-duration funds or money market funds, but less than other longer-duration debt funds.

They offer a mix of stability and return potential. But short duration funds are still market-linked investments. Your returns are not fixed or guaranteed, and the value of your investment can fall.

You can consider short duration mutual funds to invest in if:

• You have a 1-3 year goal: These funds can fit goals where you do not need the money immediately but also do not want to stay invested for a very long time. But if your goal is to invest for less than one year, you can explore liquid funds or money market funds.
• You want a balance between higher returns and volatility: A short duration fund puts your money into debt instruments instead of simply keeping it in a bank. It can be worth considering if you prefer taking slightly more risk for higher returns.
• You want to build a debt portfolio: If you already started an SIP in equity funds, adding some debt exposure, such as short-duration schemes, can give your portfolio a different risk profile.

When you invest in a short duration scheme, the fund manager uses that money to buy debt and money market securities. The portfolio is built in such a way that its Macaulay duration stays between 1 and 3 years. As these instruments mature, the manager replaces them with other securities.

During the process, the fund earns interest income and its NAV changes. Changes in bond prices in relation to market interest rates also have an effect on the fund's NAV. Credit events can also affect the portfolio. Your investment value can change accordingly.

Let's assume a scenario where you invest ₹10,000 in a short duration fund. If the NAV is ₹20 at the time of investment, you receive 500 units (₹10,000/₹20).

Now suppose the NAV rise to ₹20.60, your investment would then become ₹10,300 (500 units x ₹20.60), giving you a profit of ₹300.

However, the NAV can also fall. Actual returns depend on various factors such as the securities held by the fund, interest rates, credit quality, and expenses involved.

• A middle ground within debt funds: Short duration mutual funds sit between shorter-duration options and longer-duration debt funds. This gives you another choice when building the debt portion of your portfolio.
• Potential for income from debt securities: The securities held by the fund can generate interest income. The fund's overall return can also be affected by changes in bond prices.
• Diversification across securities: Instead of putting all your money into one bond, the fund can hold a portfolio of different debt and money market instruments. This can spread exposure across issuers and securities.
• No fixed maturity or lock-in: These are generally open-ended funds. You don't have to wait for the entire portfolio to mature before redeeming your units. However, an individual scheme may have an exit load or other applicable conditions.
• Useful alongside equity investments: If you have been investing mainly in large-cap funds, flexi-cap funds or other equity schemes, you may use debt funds to diversify your overall portfolio.

• Credit risk: A bond issuer may face financial trouble or fail to make payments. The impact depends on the security and its weight in the portfolio. This is one reason to check the fund's credit quality before investing.
• Interest rate risk: A rise in rates can put pressure on the prices of existing bonds. Short duration funds can see NAV fluctuations. This is because bond prices and market interest rates normally move in opposite directions.
• Liquidity risk: Some debt securities may be harder to sell quickly during stressed market conditions. This can affect the portfolio's value.
• Reinvestment risk: When securities mature, the fund manager may need to invest the money again. If market yields are lower at that time, the new investments may earn less.
• Returns risk: Unlike a fixed-rate deposit, a mutual fund doesn't promise you a fixed return. Even a debt fund can deliver negative returns over a particular period.

Interest-rate and credit risks can vary across debt schemes. So, don't assume that every short duration fund has the same level of risk.

All three are debt funds that mainly differ in the type and duration of securities they are designed to hold. That difference can affect how much their NAV reacts to interest-rate movements. Here's a quick comparison:

Looking for the best short duration mutual funds is not about finding the scheme with the highest recent return. A better approach is to see whether the fund fits your goal and risk. Here are a few things to check:

• Look at the portfolio: See where the scheme has invested your money. Check the mix of government securities, corporate bonds and other instruments.
• Check credit quality: Higher-rated securities generally indicate stronger credit quality. But ratings are not a guarantee that an issuer cannot default.
• Understand the duration: Stay aware of where the portfolio sits within the 1-3 year range. A fund closer to the upper end may react more to interest-rate changes than one with a shorter duration.
• Don't chase recent returns: A fund that performed well last year may not necessarily be the right choice today. Look at performance across different market conditions.
• Check costs involved: Compare the expense ratio and any applicable exit load. Small costs can matter when returns are moderate.
• Match the fund to your goal: If you need the money in a few months, a liquid fund or money market fund may be a better choice. If you can stay invested longer, you can also consider medium duration funds or other debt schemes based on your risk level.

The best short duration funds are ultimately the ones that fit your time horizon, risk tolerance and overall portfolio.

You can set up an SIP in a short duration fund on Millions in a few minutes:

• Download the Millions app from Google Play Store or iOS App Store.
• Enter your details and finish KYC to create your free account.
• Log in and search the curated mutual funds to find a short-duration fund that fits your needs.
• Select the fund, tap SIP, and choose whether you want to invest weekly, daily or monthly.
• Enter your investment amount, select your SIP date and complete the payment.

Your SIP is all set! A short duration mutual fund can be useful when you can give your money some time to grow without taking on the risk level of equity. You can start with an amount that feels comfortable and later build a broader portfolio with options such as large and mid-cap funds, corporate bond funds, or multi-asset allocation funds, depending on your goals.