Last Updated on December 6, 2023 at 8:00 am
A reader requested a discussion on instruments suitable for short-term goals. So let us do just that. The definition of what a short-term goal is is arbitrary. The unsubstantiated thumb rule is to avoid all equity for any “need” five years away or less. “Wants” are typically flexible, and one can afford to include some equity even for short-term goals.
In this article, we shall only discuss planning for “needs” and assume the five years or less thumb rule is reasonable. So we “invest” for long-term needs and “save” for the short-term.
“Save” means 0% equity, and “invest” means equity + debt in “suitable” proportions. For example, “How much equity is recommended for a six-year goal?”. An experienced investor can afford 10% or 15% equity, while a newbie should stick to 100% debt(fixed income).
In another article, we will discuss asset allocations and stick to 100% fixed income for a short-term goal. So what is the goal here? Some say, “they want better returns than a fixed deposit,” but have no clue about the risks involved.
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The primary goal is to avoid visible risks (as measured by volatility) and invisible risks (e.g. credit risk, poor management etc.). What about inflation? To try and beat realistic inflation, we need to take on visible/invisible risks. Over five years, the impact of inflation is only marginal. This can easily be compensated by most investors by investing a little more. So inflation is not a concern for choosing the instruments, but it is important for arriving at the final corpus.
List of instruments suitable for short-term goals
- Fixed deposits or recurring deposits from “too big to fail” banks (SBI, ICICI, HDFC) or from the post office (which has a 100% sovereign guarantee). This should be the go-to choice for most investors, especially newbies.
- Those uncomfortable with investing in debt mutual funds from April 2023 due to the change in taxation from 20% with indexation to as per slab can also stick with FDs and RDs.
- Money market mutual funds. These are easy to choose as there is credit homogeneity across the category. The credit risk is low, and the interest rate is also relatively low. This will be more tax-efficient than an FD/RD if your need is more than 3Y away.
- Liquid funds. A fund with a clear mandate and stable historical portfolio quality.
Fund recommendations are available here: Handpicked List of Mutual Funds (PlumbLine). With mutual funds, one must not fixate on a particular return expectation. They are truly market linked.
The following options are a bit more adventurous or require more understanding and research. The typical retail investor should avoid these unless they are willing to learn. These are not our recommendations and are merely listed as possibilities. All of them can be quite volatile and have credit risk. We urge caution before and after investing in these!
- Arbitrage mutual funds (< 5Y)
- Ultra short duration (not term!) mutual funds. See: Can I use ultra short-duration funds instead for short-term goals? (~5Y)
- Low-duration funds and short-duration funds. (<=5Y)
- Equity-savings funds (5Y).
- Conservative hybrid funds (5Y)