You have cash that’s just sitting there and not earning enough returns…
You are acutely aware of not letting your money sit idle as it is just loses its value over time due to inflation…
…but you also need this money in a short while.
And you are wondering if you know the best short term investment option that you can avail of for this short a duration.
Let’s see if I can help you…
In this post, I will be highlighting 8 good short-term investment options for you to choose from. I will also briefly cover 3 investment vehicles that you should not choose for your short term goals even if your adviser recommends those to you.
But before we get on to the recommendations, let’s cover some basics…
First, what exactly is a short term investment?
A short term investment is when you invest your money for relatively shorter time horizons. The investment period may vary from 1 day to a few years. But, generally, anything up to 3 years is considered to be as a short term investment. Some folks (like me) consider anything less than 5 years as short term.
These investments are geared for a low risk and moderate return profile and should typically result in steady returns. Safety of capital combined with good liquidity and somewhat predictable returns are the hallmarks of a good short-term investment.
You will typically make use of these investments when you are looking at providing for expenses that you know are going to happen in next few years. Some examples being:
- Buying a new car or motorbike
- Saving for your kid’s graduation or MBA in let’s say 2-3 years
- Renovation of your home
- Purchase an electronic gadget
- Saving for higher studies in next few years
- Family vacations
- Planning to buy jewelry or a TV or something else that’s mostly discretionary
Whatever your planned expense is, you need to find an appropriate investment plan. Hopefully once you go through this list, you should be able to decide which option is the best fit given your goal, your time-frame and your risk-return profile.
Ready? Here we go…
1. Savings Bank Account
This should not be a surprise at all…
Savings account is the simplest and easiest way to save your money. They offer the best liquidity and somewhat ok returns (well... it's better than holding cash).
Most banks will offer about 3.5%-4% as returns on savings accounts while some like Yes bank and Kotak Mahindra will go as high as 6%. This interest is typically credited quarterly.
As you probably know, 4% doesn’t really beat inflation and hence purchasing power of your money actually reduces as time goes on.
Recently, payment banks like those from Paytm and Airtel have commenced operations. These banks offer rates as high as 7% when it comes to savings bank accounts
The biggest advantage of savings accounts is the excellent liquidity it provides.
You can access your money at any time and at any place. You can visit your bank branch or ATM to withdraw cash or you can simply use net banking or debit card to make electronic payments. There is almost no restriction when it comes to you using your money.
Another good part about this option is that the interest up to INR 10000 per year is completely tax free. However, any amount that’s more than INR 10k will be taxed according to your current tax slabs.
Go for this option when you need extreme liquidity and can’t wait for more than a few hours for the money to be available.
They provide the best liquidity and great safety of capital, but have low returns (in fact the lowest of all the options in my list).
This option is most suitable for your day to day expenses.
2. Short term fixed deposit
This should be yet another familiar option.
Fixed deposits (alongside recurring deposits) have been a norm in Indian households for a long time. And for a good reason.
When it comes to FDs, you have a wide choice of investment duration, ranging from 1 day to a few years. They will yield higher returns as compared to savings accounts and will net about ~7-8% on an average. Further, the initial interest rates are guaranteed for the complete duration of investment, regardless of the prevailing scenario.
Do note that FD returns (which are about 7-8% in absolute terms) are subject to taxes. Post taxes, effective returns of FDs are between 5% and 6%, though the exact returns vary as per your tax slab.
In fact, if your returns go beyond INR 10000 in a financial year, your bank will deduct TDS on your behalf. FD interest is not tax-exempt even if you earn less than 10000 INR in a financial year.
Even if bank hasn’t deducted the TDS, you will still need to declare an FD interest as your income and pay taxes on it as per your slab.
You are liable for tax on FD returns even if you don’t redeem your deposits in the financial year. Income tax rules state that you have to pay taxes on the interest you earn regardless of whether you redeemed the FDs or not in that year.
Most banks offer slightly higher rates for senior citizens when it comes to FDs.
FDs are an extremely convenient option and these days you can simply book and redeem them through net banking. So you or your parents won’t really have to stand in long queues as was the case in time-past.
Choose your deposit duration carefully as there is typically a pre-mature withdrawal penalty of about 1%.
Ask your bank for the auto-sweep facility. Essentially, you get the high returns of FDs while enjoying the liquidity of a savings account.
FDs are a good choice for people who are extremely clear about the duration of their short-term investments, want little to no risk and still want higher returns when compared to saving bank accounts. They are not very good from tax saving perspective though.
FDs provide reasonable liquidity, good safety of capital and moderate and predictable returns. They are a suitable option for anything except your day to day expenses.
3. Post Office Term Deposits
Post office term deposits (POTDs) are similar to bank fixed deposits. Essentially, you save money for a fixed period of time and get a guaranteed interest rate for the entire term of your deposit. These deposits are backed by the government of India so they are risk free.
POTDs get about 7%-8% interest. This interest is calculated each quarter and the actual amount earned is paid to your account once a year.
POTDs are somewhat liquid as premature withdrawal is possible after six months.
You will earn 4% interest if the withdrawal is made between six months and one year. If the premature withdrawal happens after one year, you will get 1% lesser rate than the actual rate for new tenure.
For less than a five year duration, the interest you earn on POTD will be fully taxable. However, unlike fixed deposits, there is no TDS deduction done by post office regardless of how much interest you earn in a year.
In essence, POTDs are almost as good as FDs when it comes to returns, but they are not as flexible or as convenient. While you can open a POTD account at any head or general post office, you will need to visit the post office to operate your account unlike bank FDs where most operations can happen online.
4. Liquid Mutual Funds
… aren’t they risky?
If yes, why am I suggesting them as a good short term investment plan at all?
Well, you are not alone in asking that risk question…
A lot of people still fear mutual funds and are a bit reluctant when it comes to considering them as part of a their short term investment plans.
However, mutual funds can be an excellent choice (even for short term durations) if you know what you are doing.
Essentially, mutual funds can either invest in equity or in debt. For our purposes (of short term investments), you should look at debt only mutual funds. Equity mutual funds can potentially generate higher returns, but they are only suitable for long term investments (definitely more than 5 years, and as high as 10 years).
As you may have heard so many times – mutual funds are subject to market risks – and this is true for all mutual funds, but like I implied earlier, this risk can be minimized if you choose your debt fund carefully.
The first mutual fund category, we will consider for short term investments, is liquid funds.
Liquid mutual funds invest in short term government securities and certificate of deposits with a maturity period ranging between 4 and 91 days. In other words, liquid funds can only invest in those securities that mature in less than 91 days.
These funds will have returns ranging from 5% to 7%. Do note that unlike FDs, liquid fund returns are not fixed or guaranteed and will change as per the prevailing interest scenario.
However, they offer mostly steady returns and are the least risky option amongst all mutual fund types. In fact, it’s rare to see a dip in liquid fund net asset value as the underlying investment is fairly secure.
Liquid funds, as the name indicates, are highly liquid. SEBI mandates 1 business-day redemption, though some schemes like Reliance money manager offer same day redemption too.
Liquid funds are considered to be amongst the best short term investment options. Based on past data, liquid funds will generate much higher returns as compared to savings accounts with almost equally good liquidity. In fact, their returns rival those from FDs and they offer better liquidity when compared to most fixed deposits.
Like FDs, liquid fund returns are too subject to taxes. However, unlike FDs, instead of paying taxes every year, you are only liable for taxes on the amount that you actually redeem.
Further, if you keep the money in the fund for more than 3 years, you will be charged long term capital gains tax, which is indexed and hence your tax outgo is typically much lower compared to fixed deposits.
Liquid funds are what you should choose if you are planning to park your money for a short while or if you are not clear about exact investment time-frame.
Tip: ICICI Prudential liquid fund or Franklin Templeton Treasury management are my recommended options for liquid funds. For a larger list of suggested liquid funds, look here
Liquid funds offer good liquidity, great returns, high predictability and are suitable for most investment purposes, except day to day expenses (though Reliance money manager with a debit card is trying to change that too).
5. Ultra short term debt mutual funds
If you have an investment horizon that ranges from a month to about 3 years, you may go for debt mutual funds. As is the case with liquid funds, debt mutual funds too invest in bonds or securities.
But, unlike liquid funds which are governed by the 91 day rule, there is no such rule for debt funds. They can invest in securities that mature in more than 91 days or less than 91 days, they have complete flexibility.
These funds come in many shapes – ultra short term funds, short term funds, gilt funds, FMP funds and dynamic funds. In fact, liquid fund is a type of debt fund too.
Both short-term and ultra short term debt funds are conservative debt funds with a goal of safeguarding capitaland posting modest returns while other fund types optimize for higher returns at the cost of higher volatility.
Only recommended options from a short term investment perspective are ultra short term and short term funds. You may look at FMPs too, but the rest are simply too risky for short term investments.
Let’s look at ultra short term debt funds first…
Ultra short term mutual funds typically invest in securities typically maturing between 7 days to 18 months.
As the name indicates, they are suitable for shorter time horizon investments. Their return is slightly higher than corresponding liquid plans.
These funds have a liquidity period of about 2 business days i.e. from the day you place the redemption request, it will take up to 2 business days for the amount to be transferred to your bank account. But unlike liquid funds, no fund house right now offers same day redemption or a debit card facility for ultra short term debt funds.
One risk with these funds is that there is no standard regulatory definition that the fund house has to adhere to. One fund can operate almost like a liquid fund and have most securities maturing in less than 91 days while the other may behave more like a short term fund with longer duration securities.
For this reason, the choice of fund becomes extremely important.
Two options, I typically recommend to my friends, are ICICI Prudential Flexible Income plan (similar to liquid funds, highly rated securities, returns are higher than those of liquid funds) and Franklin Templeton ultra short bond fund (higher maturity, invests in lower rated securities, higher returns compared to most other ultra short term funds).
Ultra short term funds are suitable for any investment horizon that’s longer than a week, offer slightly better returns than a liquid fund and have good liquidity. They are a great alternative to liquid funds and FDs. They carry somewhat higher risk compared to these options though .
6. Short term debt mutual funds
Another variation of debt funds that’s suitable for short term investments is short term debt mutual funds. Compared to ultra short term funds or liquid funds, these funds typically invest in securities with a much higher maturity duration (average maturity can range as high as 2-3 years).
Unlike liquid funds or most ultra short term funds, a lot of short term debt funds will have exit loads i.e. you will have to pay a fee if you redeem before a pre-defined period. This is similar to pre-mature withdrawal penalty as in case of FDs. After this exit period is over though, you can redeem at any point of time without any penalty.
Short term funds offer potentially higher returns as compared to liquid funds and ultra short term funds but these higher returns come with a higher risk as well. It’s not unheard of debt funds that lose their NAVs because the underlying security went bad or is unrecoverable.
Short term funds are a good fit for scenarios where you want to invest for more than 3 months and want slightly higher returns as compared to liquid or ultra short term fund. Do note that these higher returns come at the cost of higher risk.
7. Fixed Maturity Plans
Fixed maturity plans or FMPs as they are normally called are close-ended debt funds. The investments in them can only be made during the new fund offer (nfo) period. These investments mature after a pre-defined fixed time(and hence the name).
Essentially, FMPs are a mutual fund version of fixed deposits, but unlike FDs you can’t do a premature withdrawal. Also, in case of FMPs, the returns are not guaranteed and are at best indicative. As you may see, this is kinda risky and not such a good option.
The typical duration for these funds these days is 3 years or more. This is because the debt fund accruals are subject to long term capital gains tax after 3 years instead of them being subject to short term taxation if the redemption happens prior to 3 years. The liquidity for these funds is poor and your money is locked in for the duration of the fund.
You can invest in FMPs if your investment horizon matches exactly that of the fund, you want slightly higher returns and are ok with the inherent risks associated with these funds. Do take note of liquidity restrictions before you go for this option.
8. Arbitrage Funds
Arbitrage funds are an interesting option that has become popular in recent years.
In arbitrage funds, the fund manager takes advantage of the volatility of equity markets that sometimes provides price mismatch opportunities. This is essentially an investment in stock market but buying & selling happens at the same time.
Essentially, the fund manager purchases something at a lower price in one market and sells it at a higher price in another. The difference is the profit for the fund. This is the arbitrage the fund banks upon.
These funds are safe and carry little risk as the fund managers hedge against equity movements while making buy or sell decisions.
Arbitrage funds can earn returns between 6-9% but the exact return will vary a lot. Inherently, the returns you get will be dependent upon prevailing market conditions.
If the market is volatile and unstable, there will be more opportunities for these funds to take advantage of and hence returns may be higher. But in stable markets, the arbitrage funds will typically underperform the other short term investment options.
Where arbitrage funds shine is when it comes to taxation. Most of these funds have at least 65% equity and hence from a tax perspective, they are treated as an equity fund.
What that means is that if you hold these funds for more than a year, all returns you get are completely tax-free. If you sell these funds with-in one year, you will be taxed at a 15% rate which is short term capital gains tax.
Arbitrage funds are only suitable if you are going to hold same for more than a year and are ok with inherent see-saw that will happen. For investment horizons of more than an year, this is a great tax saving investment option.
There are many other options out there that are being pitched to investors for short term investment horizons with good returns. The three most common ones are – Gold, Balanced Mutual Funds and ELSS funds.
I don’t consider anyone of these as suitable options for short term investments.
Gold is inherently subject to price variations from day to day and can result in loss of capital. ELSS funds are essentially equity funds and are only recommended for those who have a horizon longer than 5 years. Balanced funds are also mostly equity and carry similar risks as those of ELSS funds with slightly lesser risk profile.
Go for a combination of a high paying savings bank account (like RBL or Kotak) and a liquid or ultra short term debt fund.
This combination should get you good while the risk is still minimized. This is what I use.
So did you find the right option for your investment goal? Got any more questions? Let me know in the comments…