When I wrote a post “Top 10 Best Mutual Funds to invest in India for 2015″, I flooded with questions about investing in mutual funds and that too equity investment. Their eagerness is to invest in equity mutual funds, whether the period is 1-2 years or 10-20 yrs. In this post, let us concentrate the avenues for short-term investors.
What do you mean by Short Term?
There is no such standard definition. However, ideally any goal, which is less than 5 years, considered as a short-term goal. Let us understand that, again in such short-term goals few are very sure to come. For example, if your kid age is currently 16 yrs then he/she may need cash after 2 years for graduation. This you cannot avoid or postpone. Apart from such goals, you may also have some goals like buying a car after 3 years. This either you may prepone or postpone it and I think it will not affect so much to you. So few goals may be definite in nature and few indefinite.
When we have any such definite goals, then one must not take any risk and always be specific about decisions. However, for goals, which may be of an indefinite nature, then you can retain this, take flexible decisions or can drop it (if it is not feasible for you).
Now let us understand what are all options which available for Indians to invest for a short term.
1) Savings Account-One of the safest and easiest way to access your money. You have to keep money in a savings account which you may require at any point of time. Here your main motive LIQUIDITY but not earning. Ideally, you can expect around 4% to 7% return from such savings account. Banks such as Kotak offers you around 6% returns and Yes Bank around a 7 % return.
However, do remember that according to IT Section 80TTA, any individual or HUF can claim a deduction of up to Rs.10, 000 on interest earned from such savings account. Anything more than Rs.10, 000 interest income is considered as “Income from Other Sources” and taxed according to your tax slab. There is no TDS on such earned interest and Section 80TTA deduction is apart from the deduction of what you get from the Sec.80C limit of Rs.1, 50,000.
2) Liquid Funds-These are types of mutual funds, who usually invest in short-term government securities and certificate of deposits. Such short-term investments make them reasonably secure. You can easily enter and exit at any point of time. Usually, such funds don’t have an exit load. Do not try to put all your emergency fund into such funds. Because, sometimes the redemption may take around 2 days. In addition, if funds provided you ATM card for withdrawal, then there may be some daily withdrawal limit.
You can expect around 4% to 7% post tax return. However, it gives you full peace of mind as such funds invest in short maturity (4-91 days) securities. Usually, the underlying securities carry a high quality of rating like AAA and hence default risk is fully NIL. I suggest selecting the fund, which is high in credit quality and low in interest rate sensitivity.
Taxation of liquid funds is exactly like any other debt funds taxation. Therefore, if your holding period is less than 3 years, then it is taxed according to your tax slab. However, if you hold it for more than 3 years, then it will be taxed at 20% (+cess) with indexation benefit.
3) Ultra Short Term Funds or Liquid Plus Funds-These funds are slightly riskier than Liquid Funds. Because they primarily invest in short-term debt securities maturing from 90 days to 1.5 Yrs. You just need to understand one point here. For debt funds, maturity period of the underlying securities is a point to be checked along with a credit rating. Longer the maturity period means higher the interest rate risk. At the same time, lower the credit rating means higher the risk of default. These funds charge exit load in the range of 0.1-1% if funds are redeemed before a specified time period, in the range of one week to six months.
You can expect a slightly higher return from Liquid Funds. However, taxation rules are same as that of Liquid Funds.
4) Short Term Funds-These funds primarily invest in securities, which mature from 1-3 years. As I have said above, since the maturity of securities more than liquid funds and ultra short-term funds, these funds are a little bit risky. Taxation is same as that of any other debt funds.
5) Fixed Maturity Plans (FMPs)-These funds will come up with lock in (currently minimum 3 Yrs). These are again considered as debt funds and you can invest in such funds only you know about when you need money. They act exactly like your bank FDs. However, they are more tax efficient compared to FDs and you can expect better returns than FDs. Such funds are out of interest rate risk. Because funds usually hold the securities which mature either less than or equal to a maturity of the fund.
Note-I will recommend you to consider only these four types of debt mutual funds for your short-term goals. I will not recommend any Income Funds, Dynamic Bond Funds, Monthly Income Plans-MIPs (considering their equity exposure), or Gilt Funds. The simple reason is, your goal is short term, and we cannot expect any volatility in return. Our major goal is capital protection with a decent return. Funds like Income, Dynamic, MIPs or Gilt Funds hold long duration securities, which makes risky for your short term goals.
6) Arbitrage Funds-These are considered as equity mutual funds. Hence, they are more tax efficient if your holding period is more than a year. These funds may give you around 8% post tax return. You can learn more about Arbitrate Fund HERE.
However, nowadays few mutual fund companies offering you Arbitrage Plus Funds. Take a caution of this difference and see what CRISIL say about this, “Investors need to differentiate between pure arbitrage and arbitrage plus funds. In the former, the equity component is completely hedged while the latter can take unhedged positions and carry a higher risk. Only eight of the 15 domestic arbitrage funds can be considered as pure arbitrage funds”. You also take a note of exit load of these funds before investing.
7) Bank FDs or Postal Term Deposits-I think we do not need any explanation of this. If you have an internet banking facility, then I suggest booking your FDs online. The advantage is, it is easy to handle and at the same time, if you redeem online, then the you get the cash immediately in your savings account. Returns from FDs are taxable as per your tax slab (whether they are normal FDs or tax-saving FDs). You can deposit anywhere from 7 days to 10 Yrs. However, I will not suggest using this if your time horizon is more than 3 years. If the goal is more than 3 years, then the above said debt funds or Arbitrage funds are more tax efficient.
Even you can use the Post Office Term Deposits. However, when it comes to facility and service. Post Office lags behind. However, never try to go for Corporate FDs. The reason is, currently the company, which you are going to invest, may have a high credit rating. However, after a few years, if the company not performed well, then the same rating agency may downgrade it. Then is it possible for you to come out of the deposit? These deposits may offer you a higher interest rate than Bank FDs. However, such high return will come with associated risks.
8) Recurring Deposits (RDs) -This is one more type of secured investment. This product is ideally suitable to those who not able to invest a lump sum and looking for monthly investment. Either you can use Bank RDs or Postal RD. Ideally bank offers RD of minimum tenure with 6 months to a maximum of 10 Yrs. Interest received on RD is taxable as per your tax slab.
9) 5-Yrs National Savings Certificate (NSC) -You can invest in Postal NSC of 5 years, only if you are sure that goal is exactly at 5 years from today. You can claim deduction under Sec.80C. However, the interest on NSC will be taxable.
I wrote a post on how one can reduce their tax liability on NSC interest. Please go through and read a below post.
10) Monthly Income Schemes (MIPs) -If you are expecting for regular fixed monthly income, then I suggest to go for Postal MIP. However, I do not recommend you the MIPs offered by mutual funds. The reason is, even though the name of such funds is MIP, but there is no guarantee that they offer you monthly income. Ideally, these funds invest around 10% to 20% of a portfolio in equity and rest in debt instruments (usually of higher duration). Hence, these two points make it bit risky than the other debt funds I referred above. Why take a risk, when you have the same taxation like other debt funds discussed above? Hence, restrict your monthly requirement to Postal MIP or Senior Citizen Savings Scheme (SCSS) (if you are senior).
The above list may not be exhaustive. However, I felt it enough to end this post 🙂 Any alternative suggestions??