Financial planning, a lot of the times, is about investing for the long term. However, there are many needs that have to be met in the short term.
People invest for the shorter durations primarily because their goal is near or they do not want to take the risk of locking in their money for a longer tenure. Although there is no single defined period for short-term investments, anything from 7 days to less than 12 months can qualify as short-term.
There are various instruments to choose from if you want to invest for the short term. These products can be clubbed into two categories - one, yielding fixed income and two, yielding market-linked return.
Fixed-income investments come with tenures in the range of 7 days to 12 months. Some of the common fixed-income products that can be used for short-term investing include fixed deposits (FDs), company deposits, post office term deposits and so on.
Market-linked products are basically debt mutual fund schemes where the average duration of the underlying securities is less than 12 months. Some of the common short term market-linked investments include liquid funds, ultra-short duration funds, and money market funds.
Here is a look at each in terms of tenure, returns, liquidity, and taxation.
1. Bank fixed depositsTenure: A bank FD is a safe choice for short-term investment. FDs come with various tenures ranging from 7 days, 14 days, 30 days, 45 days to a year or even up to 10 years. Different banks have different duration of deposits. Such deposits can even be renewed on maturity and hence, funds can be reinvested if the need is not there. Under the deposit insurance and credit guarantee corporation (DICGC) rules, each depositor in a bank is insured up to a maximum of Rs 1 lakh for both principal and interest amounts. Most banks allow you to invest in an FD online.
Liquidity: Some banks may offer deposits that don't allow premature withdrawals. Instead of locking funds for a particular duration, an investor may spread the amount across different maturities through 'laddering'. It not only provides liquidity to funds, but also manages the 're-investment risk'. When the shortest-term FD matures, renew it for the longest duration and continue the process as and when various FDs get matured. One may even invest for a longer period and in case of need, withdraw prematurely, by incurring a penalty. If the need doesn't arise, interest can be continued to be earned.
Returns: As per the need, one may opt for monthly, quarterly, half-yearly, yearly or cumulative interest option in them. The rate of interest that banks offer is somewhat aligned to the Reserve Bank of India (RBI) repo rate and hence the bank's own cost of funds. Currently, it is around 6.5 percent per annum for most tenure of 12 months and above. Senior citizens get an additional 0.5 percent on their deposits.
Taxation: The interest rate earned is added to one's income and is taxed as per one's income slab. If the interest earned is more than Rs 10,000 a year across all branches of the bank, there is a tax deduction at source (TDS) by the bank. Read more about bank fixed deposits.
2. Company FDTenure: Unlike bank FD's, the company deposits are unsecured deposits and therefore carry a higher risk. In case of a default, the depositors have the last right on the company's asset. Both, manufacturing companies and non-banking finance companies (NBFCs) issue such deposits but it's only the former who have a short-term deposit option. Company deposits offered by NBFCs come with tenures of more than one year.
Liquidity: Although, premature exit is allowed, it's at the company's discretion to honour it. Further, there are penalties in place depending on the tenure the deposits are held before applying for surrender.
Return: The interest rate on these deposits may be 1-2 percent higher than bank FD but the risk of losing the entire principal and not just the interest is high, even if the deposits carry high ratings. As per the need, one may opt for monthly, quarterly, half-yearly, yearly or the cumulative interest option. Currently, most such deposits are offering around 7.5 percent per annum.
Taxation: The interest rate earned is added to one's income and is taxed as per one's income slab. If the interest earned is more than Rs 5,000 a year across all branches of company, TDS will be cut by the company.
Read more about company deposits.
3. Post office time depositsTenure: One can invest in post office time deposits which have tenures of 1, 2, 3 and 5 years.
Liquidity: The interest payments in case of time deposits are annual. The premature withdrawal of a time deposit is not allowed before the expiry of six months. One may surrender the deposits after that, however, the amount of interest recovered in case of premature withdrawal of the deposit will be at a reduced rate of interest.
Returns: Once invested, the returns are fixed and assured with sovereign guarantee for the entire period. For short-term, one may invest in a 1-year time deposit where the interest is payable annually, but calculated quarterly. Every quarter, the rates are re-set by the government which applies only on fresh investments made in that quarter of the year. Currently, ( April-June,2018), the rates are 6.6 percent to 7.4 percent for 1-5 year time deposits.
Taxation: The interest rate earned is added to one's income and is taxed as per one's income slab.
4. Recurring Deposits
In all the other short-term options, the investment has to be done once, i.e., as a lump sum. However, if one wants to save regularly for a short-term, say for 6, 9 or 12 months, a bank recurring deposit (RD) can come in handy. In RD, one has to invest at a regular intervals for a fixed period and up on maturity will receive a lump sum amount. Most banks allow investing in a RD online.
Tenure: One may open RD for a tenure as low as 6 months and then in multiples of 3 months, up to 10 years.
Liquidity: Generally, the RD account has a minimum lock-in period of one month. In the case of premature closure within a month, no interest is paid to the depositor and only the principal amount is returned. On pre-mature withdrawal of the deposit, interest will only be calculated at the rate applicable for the period of the deposit.
Returns: The interest rates for recurring deposits will be the same as the rate applicable for a regular bank FD. Currently, it is around 6.5 percent per annum for most tenure of 12 months and above. The interest rate will be applicable as on date of making the first instalment.
Taxation: The interest rate earned is added to one's income and is taxed as per one's income slab. If the interest earned is more than Rs 10,000 a year (including interest on bank deposits) across all branches of the bank, TDS will be cut.
5. Sweep-in FD
For parking funds for the short term, one generally keeps it in a bank savings account which offers the highest liquidity. Here's a alternative - A sweep-in fixed deposit known by different names like money multiplier or 2-in-1 account. One may open such a sweep-in FD by visiting a bank branch or through Net banking.
Tenure: Though you the option to fix the tenure of the FD, most banks give a fixed tenure of 12 months.
Liquidity: The premature withdrawal penalty is usually around 0.5-1 per cent of the interest payable.
Returns: The interest rate is mostly similar to that of bank FDs. Currently, it is around 6.5 percent per annum for most tenure of 12 months and above.
Taxation: The interest rate earned is added to one's income and is taxed as per one's income slab. If the interest earned is more than Rs 10,000 a year across all branches of the bank, TDS will be cut by the bank.
Read more about Sweep-in FDs.
6. Debt mutual funds
Below are four debt funds which may be used to park funds for the short-term as the maximum maturity of the underlying securities in them is not more than 12 months.
Tenure
Liquid fund: Here, the investment is made into debt and money market securities with maturity of the underlying securities up to 91 days.
Ultra-short duration fund: Investments are made into debt and money market instruments where the maturity of the underlying securities is between 3 months and 6 months.
Low duration fund: The investment is made into debt and money market instruments where the maturity of the underlying securities is between 6 months and 12 months.
Money market fund: The investment is made into money market instruments where the underlying securities have a maturity of up to one year.
Liquidity: The liquidity is high in these funds and units can be redeemed in quick time.
Returns: The returns, however, are not assured nor fixed. Currently, you can earn about 7 percent per annum. For optimum results, match your investment horizon with the maturities of underlying securities of these funds and then invest.
Taxation: Gains made under 36 months of holding them are to be added to one's income and taxed accordingly. However, gains made above 36 months are taxed at 20 percent post-indexation.
Read more about debt mutual funds.
What you should do
When the requirement is to invest only for the short term, the post-tax returns should not be overlooked. In all the above investment options, the income earned gets added to one's total income in that financial year and taxed according to one's income slab. Further, if you need to invest for a short duration, remember, it will be more for capital preservation rather than wealth creation.
It's good not to compromise on safety for that extra bit of return in the short-term. Base your decision to invest primarily on safety and liquidity of the investment rather than hinging on the returns.
