Five ways to invest for the short term

Source: Tavaga Research

We look for short-term investment plans when we want to keep our principal safe and still earn a small return. Of course, the overriding objective for a short-term plan would be easy liquidity. The investment should be easy to redeem or withdraw, given its short duration.

An investment with a duration of at least seven days to less than 12 months may be termed as a short-term investment.

One of the most important aspects of investing in the short term is principal protection, which gets more weightage than return generation. 

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Factors for short-term investments

  1. Short-term investments spell certain advantages such as liquidity. Short-term investments do not charge us an exit-load fee when we withdraw our invested money. 
  1. The safety in principal-protection comes at a cost. We will not be able to earn sizable returns on short-term investments when compared to a long-term investment. 

  1. Short-term investment plans are often less risky than long-term plans because we don’t have the luxuries of time and averaging out that come with it. It also is in line with the objective of guarding our principal in a short-term investment. Getting too adventurous would jeopardise it. 
  1. To ensure our principal is intact in the short term, we should rule out risky or volatile instruments, no matter the likely returns. It would be best to avoid company stocks and funds exposed to the market cycle.

5 places to park money for a short term 

  • Savings bank account 
  • Fixed deposit
  • Recurring deposit
  • Debt funds 
  • Liquid funds 

Short term investment avenues
Source: Tavaga

1. Savings bank account 

A savings bank account is one of the simplest options available to invest for a short term. A savings bank account may be opened with any bank without much hassle, in which we may easily deposit and withdraw money. And, most of us may already have one. Savings bank accounts generally offer an interest rate of around 3-3.5 percent a year. 

Even if we make peace with the staid interest in a savings bank account for a short span, the spate of banks being hauled up by RBI for their errant ways may have shaken our confidence. After the PNB scam and the Yes Bank freeze, a cooperative banks based out of Mumbai, CKP Cooperative Bank, has been the latest to see its license revoked on May 2. Of course, this budget, the government under the Deposit Insurance and Credit Guarantee Corporation has increased the deposit insurance on our deposits from coverage of Rs 1 lakh to Rs 5 lakh. 

2. Fixed deposits

Fixed deposits (FDs) are one of the least volatile investments available to us, given the current mercurial markets. 

These investments lock in our deposit for a given period of time, but we may withdraw the amount after paying a small penalty. The benefits of fixed deposits include a fixed rate of returns, which sets the investor free from market volatility. 

A bonus is the income earned on FDs being tax-exempt till Rs 10,000. In case the returns are more than Rs 10,000, then a 10 percent TDS is cut and we receive the remainder. 

The tenure of FDs may vary from seven days, 14 days, 30 days, one year to even 10 years. If we don’t withdraw prematurely, we may even renew the policy on its maturity. 

3. Recurring deposits

Recurring deposits (RDs) are somewhat similar to the FDs, the difference being we put in a lump sum to start an FD but deposit periodically in an RD. 

The tenure of RDs may range from a minimum of six months and to multiples of three months thereafter,  up to 10 years.

RDs may come in with a partial lock-in as well, say one month of lock-in of our principal. If we withdraw before the first month is up in this case, then we would receive our principal without any additional interest earned on it. 

The taxation of the income earned in an RD is the same as with FDs.

4. Debt funds 

These are mutual fund schemes with the objective of providing stable returns with low risk. 

The AMC issuing the debt fund invests the corpus or pooled investments in debt instruments such as treasury bills, commercial papersgovernment securities and other instruments that mature in a short time (in the range of one-two years). 

However, it is to be noted that debt funds are exposed to risks such as credit risk, interest rate risk, and inflation risk. 

Given the current market conditions when liquidity is drying up, we should be highly skeptical about investing in debt funds as the probability of the risk playing out is high. We recently saw how Franklin Templeton decided to close six of its credit risk funds (debt funds) as liquidity dried up.

5. Liquid funds

These are mutual funds that aim to provide a high degree of liquidity and capital protection to investors. 

The corpus of the fund is invested in money market instruments. They include investment products with a really short tenure, ranging from 60 to 90 days. 

As the underlying instruments of liquid funds have a short lifespan, they are not exposed to credit risk in the same degree as debt funds are. 

Based on our goals, time at hand, and risk profile, we may choose one or more of these options for a short-term investment spread. All of these investment vehicles could easily hold our principal amount for a year and earn us additional income, albeit at a conservative rate. 

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