When you think of investments, it’s often typically considered to be investing for the long term. Say for a period of 3 years, 5 years, 10 years, 20 years or more. But a good investment portfolio doesn’t just comprise long-term investment options; it also needs to have short-term investments. This is because while investing for the long term helps you meet your life goals later in life, like saving up for your children’s education or planning for retirement, short-term investment options meet an important financial need – liquidity.
What is short-term liquidity, and why is it important?
From an investor’s point of view, liquidity is simply the ease with which an asset can be converted to cash or cash equivalents. For instance, say you wish to convert a residential property to cash. It may take you anywhere between a few weeks to a few months to execute the sale and receive liquid funds in exchange. This puts the liquidity of an asset like property quite low on the scale.
On the other hand, there are many short-term investments that you can easily divest from, thereby converting them to cash or cash equivalents. These assets rank high on the liquidity spectrum. Liquidity is important because in case of any financial emergency, if you’re short of funds, you can rely on a liquid asset to meet your emergency cash requirements.
For the conservative investor who is looking for safe, short-term investments, debt mutual funds present a lucrative investment opportunity. There are many different types of debt funds suitable for short-term investment horizons. Let’s take a closer look.
Matching your investment horizon with the right investment option
Short-term liquidity could be a blanket term, because the duration of that ‘short-term’ horizon could vary from one individual investor to the next. So, if you’re looking for short-term liquidity, there are different types of debt mutual funds that meet your specific requirements.
Here’s a preview of the details.
Time horizon: 1 day
This is the shortest possible investment horizon that you can invest for. Interestingly, the debt fund market offers an option for investors who are looking to invest for this extremely short duration too. If that sounds like what you need, then overnight funds are the answer.
Overnight funds, which are highly liquid, invest in securities that have a maturity of 1 day, like money market instruments. The liquidity and convenience are quite high, although you cannot expect very high returns here. If you’re looking for safe investments to park your funds overnight, these short-term investments are ideal.
Time horizon: Less than 3 months
Say you want to take a vacation a few months from now. In that case, if you don’t want your funds to sit idle, or if you want to earn some returns on your funds, you can choose to park your cash in liquid funds. These funds invest in debt securities that have less than 91 days to maturity.
The two key advantages of liquid funds are that they offer high liquidity coupled with minimum NAV volatility. And of course, while the returns may not be sky high, they certainly have the potential to be higher than what your average savings account offers.
Time horizon: 3 to 6 months
If you wish to invest for a time horizon of 3 to 6 months, there are debt mutual funds that can help you fulfill that financial goal as well. In this case, ultra-short duration funds are what you’re looking for. If you have an investment horizon of at least 3 months, but no more than 6, then these funds are ideal.
They are low-risk short-term investments that offer a slightly higher return than liquid funds or even fixed deposits. Ultra-short duration funds typically invest in debt instruments and money market instruments.
Time horizon: Up to 1 year
When you think of short-term investments, you most likely think of a 1-year time horizon. If you’re looking for an investment option that gives you returns within the year, money market funds and low duration funds are good alternatives to consider.
These funds are ideal for investors with low levels of risk tolerance, since they invest in debt instruments with maturity periods going up to one year. They deliver returns from interest income, and the fact that the duration is slightly longer also gives you some opportunity to earn capital gains over the investment period.
Time horizon: 1 to 3 years
If you have no immediate need for highly liquid assets, but nevertheless wish to include some short-term investments in your portfolio, then short duration funds, banking and PSU funds and corporate bond funds may be good choices. Do keep in mind that the modified duration of both the banking & psu debt fund and corporate bond fund should not be more than 3 years. These debt mutual funds invest in a combination of both short-term and long-term debt instruments.
They come with investment horizons ranging from 1 to 3 years and owing to this duration; they have the potential to earn higher returns than debt mutual funds with a much shorter tenure.
So, you see now that if you’re looking for investments that fulfill the need for short-term liquidity, there are many kinds of debt mutual funds you can consider depending upon your short-term goals. Tata Capital Wealth management offers many short-term debt funds and low duration funds for investors like you, who wish to capitalize on NAV movements and simultaneously also enjoy the advantage of high liquidity.
12 January 2021
5 mins read
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