Short-Term Investment Options

Sanjay, 30, is working in a software firm as a manager. Sanjay is married with a two-year-old child and has no big liabilities at present.  His job is well paid and he saves enough money for future investment. He has some short term needs like annual vacation, parking money, emergency pool etc. He has certain medium term needs like saving for buying a car, down payment of home etc. He has some long term needs too like kids education, their marriage, family obligations etc. Moreover, he wants to invest for his retirement needs also.

He is little confused as how to go about to invest his money so that he can fulfill all his obligations. He consulted his friend Amar, who is a financial analyst. Amar told Sanjay that since his objectives are different, he should invest accordingly to meet his short-term, medium-term and long-term needs. Amar also elaborated on different options available in each category:

Short-term investment options

      I.        Short-term FDs:

Nothing beats short term FDs when it comes to security and liquidity. It is better to opt for bank deposits over company deposits, which do offer high returns but are risky. The advantage with Short-term FDs is that it provides higher interest rate than saving accounts and it is as safe also. If you think that you are going to need this money at a particular time in future, it is better to shift that money from your saving account to short-term fixed deposit.

    II.        Short-term floating rate funds:

The major drawback of an FD is that your money is locked in at a particular interest rate. So if the interest rate increases after opening a deposit account, you won't be eligible to benefit from this rate hike. E.g. if your FD carries an interest rate of 6 per cent and if the new interest rate become 6.25 per cent, you will still earn 6 per cent on your deposit. If you try to liquidate this deposit, you will end up losing interest for premature withdrawal.

To overcome this drawback of the FD, you can opt for floating rate funds. The interest rate here varies in accordance with the change in their benchmark index rate. So when the benchmark interest rate increases, the returns from these funds increase and vice versa.

However these returns come at a price. They are riskier than a traditional FD. Moreover, not all these funds are available to small investors as they require very high investment.

   III.        Liquid Funds

A good avenue to invest for a short term and earn reasonable returns is a liquid fund. Liquid funds invest in short-term debt instruments with maturities of less than one year. Therefore, they invest in money market instruments, short-term corporate deposits and treasury. The maturity of instruments held is between three and six months. A liquid fund provides good liquidity, low interest rate risk and the prevailing yield in the market. Liquid funds have the restriction that they can only have 10 per cent or less mark-to-market component, indicating a lower interest rate risk. They invest in money market instruments such as certificate of deposits, commercial paper and treasury bills, either on an overnight basis, for 10 days or a month. These funds can be used to park cash for a short term. These funds are used to earn a definite amount in less than a year.

Liquid funds are used primarily as an alternative to short-term fix deposits. Liquid funds invest with minimal risk (like money market funds). The minimum investment size in a liquid fund varies from Rs. 25,000 to Rs 1 lakh.

Liquid funds have an exit load if the investor redeems before the lock-in period. But in most cases, the lock-in period is quite low – varying from 7 to 10 days. Liquid funds score over short term fix deposits. Banks give a fixed rate in the range 5%-5.5% p.a. for a term of 15-30 days. Returns from deposits are taxable depending on the tax bracket of the investor, which considerably pulls down the actual return. Dividends from liquid funds are tax-free in the hands of investor, which is why they are more attractive than deposits. The sole disadvantage of liquid fund is that investors cannot take the advantage of higher returns being offered by long-term instruments.

   IV.        Saving Account

Savings Bank Accounts are meant to promote the habit of saving among the citizens while allowing them to use their funds when required. The main advantage of Savings Bank Account is its high liquidity and safety. On top of that Savings Bank Account earns moderate interest too. The rate of interest is decided and periodically reviewed by the Government of India.

Savings Bank Account can be opened in the name of an individual or in joint names of the depositors. Savings Bank Accounts can also be opened and operated by the minors provided they have completed ten years of age. Accounts by Hindu Undivided Families (HUF) not engaged in any trading or business activity can be opened in the name of the Karta of the HUF.
The minimum balance to be maintained in an ordinary savings bank account varies from bank to bank. It is less in case of public sector banks and comparatively higher in case of private banks

 
It is advisable to seek the following information from bank before opening the account:

• Minimum balance requirements.
• Penal provisions in case the balance falls below the minimum stipulated amount
• Penalty in case of return of cheques issued or instruments sent on collection.
• Collection facilities etc. offered and charges applicable.
• Details of charges, if any for issue of cheque books and limits fixed on number of withdrawals, cash drawings, etc.