Investing for the short term has its benefits. Lets look at some of the short term inverstment options we have available to us.
Most people think long term is the only way to go when investing, but there may be times when an investor may find some surplus cash without a clear timeline of investing it again. This could be because of annual performance bonus in a job, the maturity of an instrument he was invested in, or an unexpected windfall from some other source.
In such a case, investors usually let this money lie in the bank before deciding its future course. As stable as that option is, there are short-term avenues which can be potentially more rewarding.
Short term does not mean days. It generally means 2-6 months
Bank and post office fixed deposits
Given how one defines short-term, investors can at least opt for bank and post office fixed deposit schemes in order to enhance their returns. This is especially true if short-term is defined as a 1 to 3 year period. The following table shows the interest rates on post office time deposits and is credited to India Post.
As can be seen, the difference between an annual 4% savings account rate and a 1 year time deposit is sizable.
Fixed deposits are a sureshot and easy way to get a little bit extra returns than saving accounts in the short term. There is also negligible risk and low returns.
Short-term bond funds
Short term bond funds are a feasible option for investors with a similar time-frame. The funds invest in fixed income instruments like commercial paper and certificates of deposits as well as corporate and government bonds which mature in less than a year up to 3 years. These funds can implement various strategies to provide attractive returns to investors based on the interest rate environment.
If an investor defines short-term as a few days up to a year, the mutual fund industry provides a few other options apart from short-term debt funds.
Bonds are a good way to get close to 8-9% returns with low returns. You should be investin a part of your portfolio in bond funds irrespective of short or long term!
Some sample funds below with returns
Liquid Funds are another possible candidate for consideration. They are at the bottom end of the spectrum of debt funds in terms of risk, but that is because the magnitude of returns is also small. This implies that investors can park their money in liquid funds from a span of a few days to a few weeks.
Though their returns are a bit lower than ultra short-term bond funds and much lower than short-term bond funds, they are usually higher than that offered by a savings account, thus making them a prudent choice. Also, the redemption proceeds from liquid funds are nearly instantaneous in several cases, very much like a savings account.
Mutual fund products for the short-term
Ultra short-term bond funds are an option for those investors whose window for waiting is less than a year. Theoretically, these funds can invest in securities maturing both less than and more than 91 days. Practically, these funds invest in securities maturing up to about 1.5 years. Since the maturity profile of these funds can vary greatly from one fund house to another, investors should study the same to choose the fund which matches their requirement.
The data point to look for is average maturity of a fund. This is vital to funds from the ultra short-term category, and can greatly vary for a single fund as well, given the interest rate environment.
When investing in mutual funds for the short term period, it is a better idea to invest in balanced funds or debt funds to avoid risky exposure. Also, keep in mind the lock in period. Some mutual funds such as ELSS funds have a lock in period of 3-5 years. That basically means, you will not be able to withdraw your savings in that time period.
While it is pretty difficult for even an experienced investor to arbitrage directly, there are funds that make use of this mechanism. An Arbitrage fund leverages the difference in price in the cash and derivatives market to generate returns. So in this case, the fund buys shares of a particular company in the cash market and sells futures in the derivatives market. If the futures are trading at a premium, this leads to an arbitrage opportunity and the fund makes a profit.
Gold is also a potential short term investment instrument. While you probably wont get any drastic returns from gold in a matter of 6 months to 18 months, it is still a safer haven for investments compared to stocks or high risk mutual funds. The attractive part of about investing in gold is that historically gold has been a go to place in times of market crashes and weak economy. So Gold is a good hedging strategy of sorts if you have too much exposure in high risk investments
Related: The act of investing in Gold
We have listed above the most common short term investing options. While there might be more, the above are the most common ones. Keep in mind that while these are short term investment options, they might not be risk free. So always try to invest a small portion of your corpus only and never invest all your investments in the short term.
All in all, investors have quite a few choices when it comes to short-term investments depending on how they define short-term. Most of the funds if not all described above can be en-cashed in a matter of hours to couple days. So do not worry about liquidity. Let your money make more money for you!