How To Make Your Money Make You Rich? (Best Short Term Investment)

Last week, in one of my Corporate Investor Awareness Sessions, I was approached by a 23-year-old girl who for the first time in her life had stepped out of a small place in Uttar Pradesh to take up a Corporate role in Delhi.

It, being her first job, her monthly earnings were modest at best. Yet, she was able to save more than 50% of it. The reason she maintained a low key lifestyle was that she needed to save a substantial sum for her wedding which she thought was likely to happen in the next 2 years.

Her father was a retired Government employee receiving a small pension and her mother was a homemaker. She was therefore clear that she had to be responsible enough to fund her own wedding.

The first job is often exciting as well as intimidating. There are too many advisors and too much information to be able to digest. She, therefore, wanted to ask me how she could save for her wedding. What possible options did she have to invest her savings such that she is able to use the accumulated funds for her wedding?

The above is just one of the many instances when short term investment options are of need. There could be many other reasons we may need to save up for a short period of time.

For example, an entrepreneur who is thinking about investing in a website in a couple of months might want to park her savings in an instrument which can give her some return and safety of capital.

Let us, therefore, see which are the best short term investment options:

This is the most common instrument used by all of us. Having a savings bank account is the most basic form of savings done by any individual. Most large banks offer an annual interest rate of 3.5% for the amount parked in the savings account.

The reason this is popular is that keeping cash at home earns you nothing. A small interest rate at the bank is an incentive to encourage more people to park their surplus money in banks.

For whom are these suitable?

If you need any money to be spent within the next 7 - 10 days, then the amount should ideally be parked in your bank savings account. This ensures ease of transaction as you can visit the ATM to withdraw the money. Or, just swipe your debit card to utilize the money.  

Part of your emergency corpus. While your emergency corpus should be approximately equal to 3 months’ salary, you can park half a month’s salary in the savings account.

For villagers who have so far been keeping cash at home. Despite the rapid proliferation of rural banking, parts of rural India still go unbanked. For such people, a low-interest rate is also a good incentive for them to save in the bank account (as keeping cash at home makes it more vulnerable to be spent).

Advantages

• Highly liquid – withdraw your money from anywhere any time  
• Safe – Since banks are highly regulated entities, one can assume that funds lying in a savings account are mostly safe  
• Guaranteed interest – The rate of interest is guaranteed so one knows in advance what will be the earnings like

Disadvantages

• Low rate of interest – Given the average inflation in India has historically been around 6-7% per annum, this return leads to capital erosion.  
• Vulnerability to spend – Given that debit cards have made our lives so easy, one tends to spend more if money is lying in a savings account.
• Tax implication - Interest (in excess of INR 10,000) earned from a bank savings account is taxable at slab rate. Hence parking a lot of money in a savings account is detrimental for people who are already paying tax.

This is another common instrument which we have been hearing of since we were young. Our parents have inevitably done a few fixed deposits during their working lives. A bank fixed deposit can be opened with any bank. The tenure of the deposit can be chosen. They generally vary from 7 days to a few years. The interest payout can be chosen as quarterly, semi-annually or annually.

If one wants to take the compounding benefit, one can choose to not take any interim payout and let the interest be redeemed at maturity.

For whom are these suitable?

People who want to earn a higher rate of return as compared to a savings bank account and can lock their money for a chosen tenure. However, one should avoid FDs if interest earned leads to tax liability (because tax makes fixed deposits very inefficient)  

Senior Citizens who are not falling within the tax bracket can leverage fixed deposits for saving their retirement corpus Advantages  Liquid – One can break the FD in case of emergencies.

A penalty is usually charged in case of breaking FDs before maturity.  

Advantages

• Safe – Since banks are highly regulated entities, one can assume that funds lying in a savings account is mostly safe  Guaranteed interest – The rate of interest is guaranteed so one knows in advance what will be the earnings like.

Disadvantages

• Unable to beat inflation – FD rates at best match inflation. With education and medical inflation in double digits, FDs no longer serve to be an instrument which can lead to wealth creation.
• Tax implication - Interest (in excess of INR 10,000) earned from bank deposits is taxable at slab rate. Hence FDs are extremely tax inefficient for people who are in 20 - 30% tax bracket.

Several companies resort to raising funds by offering fixed deposit like schemes to individuals. The money so raised is utilized for the purpose of business expansion/operations by the companies.

These deposits usually offer a slightly higher rate of return as the risk element is higher than that of bank deposits.

For whom are these suitable?

People who look for modest returns (Again, tax implication makes these deposits inefficient from an investment point of view)  

Senior Citizens who are not falling within the tax bracket can leverage corporate deposits for saving a part of their retirement corpus if such corpus is not required to fund the routine expenses.

Advantages

• Higher return as compared to bank fixed deposits

Disadvantages

• Credit risk – If the company issuing such FDs are not fundamentally robust, the promised yields may not materialize. Recent defaults have proved the credit risk element of investing in corporate deposits.  
• Tax inefficient – For people in 20-30% tax bracket, there are better and less risky alternatives available. Tax implication: Interest earned from corporate deposits is taxable at slab rate. Hence FDs are extremely tax inefficient for people who are in 20 - 30% tax bracket.

Before you continue reading the article further, Checkout 3 High Cost Traps To Avoid While Investing

Liquid funds are debt mutual funds which invest the money in instruments with a maturity period of less than 1 - 3 months. This means that someone who is looking to park surplus money for a short period of time, can avail of these instruments.

Since liquid funds do not invest in stock markets, they do not suffer from the volatility that equity markets do.

It is like a savings account with higher returns than that of bank savings.

For whom are these suitable?

People who want to park surplus money for a very short period of time (7 days – 6 months)  People who are comfortable with a non - guaranteed rate of return – Unlike bank deposits, liquid funds do not guarantee the return.

One needs to ascertain the risk level by looking at the fund quality.

Advantages

• Higher return as compared to a bank savings account.
• Highly liquid – Withdraw whenever you want as these funds generally have no exit loads. However, one must keep in mind that money gets credited to your bank account within 2-3 days of requesting for redemption.
• Tax efficient – If the money stays invested for more than 3 years, the tax paid on returns is significantly lower as compared to the tax that one would pay in case of fixed deposits. This is because of the benefit of indexation available on long term capital gains.

Disadvantages

• Slight risk element may be there as these funds sometimes invest in corporate deposits. In case of a default in any corporate deposit, some impact on returns is possible. However, SEBI has started to become more stringent with these funds now.
• Tax implication: Returns from liquid funds are taxed as follows:
  1) If redeemed within 3 years from the date of investment: At slab rate
  2) If redeemed after 3 years from the date of investment: Inflation-adjusted returns taxed @ 20% Hence liquid funds are extremely tax inefficient for people who are in 20 - 30% tax bracket.

Here's How you can invest in Mutual Funds (Easily)

These are a variant of liquid funds which invest in slightly longer maturity instruments. The tenure could vary from 3 months to several years. One should look at the specific fund in order to ascertain the suitability of investment. Someone who needs money in 10 months should go for an Ultra - Short term fund and not a short term debt fund.

For whom are these suitable?

Similar to liquid funds, these funds are suitable for people who are looking to create a corpus for a short term goal. We are wrongly advised to invest in equity mutual funds if a goal is due for occurrence in the next 3 years. In such cases, one should not aim for high returns but for the safety of capital. And therefore these debt funds serve to be most suitable.

Advantages

• Same as liquid funds. These funds find appeal with people who park a major part of their emergency funds here. Since there is no constraint on withdrawal, one can redeem their money any time and yet get higher returns.

Disadvantages

• Slightly riskier than pure liquid funds as the tenor of the instruments is longer.
• Tax implication: Same as liquid funds

These are mutual funds which take arbitrage positions in equity securities. However, since they do not trade in equity, they are not subject to market risks. Arbitrage position mainly takes advantage of the price difference in securities listed on multiple exchanges.

Accordingly, the returns from such funds are also modest as opportunities to earn from arbitrage reduces as markets become more and more efficient.

For whom are these suitable?

These funds are suitable for people who are looking for modest post-tax returns in 1 –3 year period.

Advantages

• Considered as an equity investment for tax purposes. Therefore the tax implication is lower as compared to other instruments.

Disadvantages

• Low returns as arbitrage opportunities have been declining

(Hey, we also have 9 Quick Tips To Pick The Best Mutual Funds!)

These are a type of debt mutual fund which comes with a fixed lock-in period (Usually more than 3 years). Since there is a lock-in period, the fund managers of these funds are not worried about any sudden redemption requests and therefore are able to invest in securities whose tenor matches the duration of the fund. When such tenor matching happens, the payout of the instruments is matched to the date on which proceeds are to be redeemed to investors. As such, the risk level reduces. However, one should take care of the credit quality of the fund in which one invests. A low rated fund may be riskier as a credit default can adversely impact returns even with a lock-in period.

For whom are these suitable?

People who are looking for modest post-tax returns over a 3 year period.

Advantages

• Tax efficient AAA rated funds have good quality instruments and hence lower risk  Returns are slightly higher than normal debt funds.

Disadvantages

• Lock in period – One cannot withdraw the money even in case of emergencies.

As we can see, even within the short term investment options, there are a variety of instruments which are differently suitable to different people. One should reach out to an advisor in case of any uncertainty. This is especially relevant for people who are in 20-30% tax bracket as tax efficiency is critical for any debt instrument.

So Ladies are you already investing your savings somewhere? If yes, where & why?

Share in the comments below.