Investment Options To Meet Short Term Financial Goals

Short term financial goals have investment horizons of up to 3 years. Since these horizons endow lesser time to recover losses from market volatilities and corrections, such investments should lay greater emphasis on the preservation of capital and income certainty, than on the yielding of higher returns.

Below is listed 5 short term investment instruments that offer higher capital protection, income certainty and liquidity features.

Short-Term Debt Mutual Funds

Short term debt funds such as the ones with short/ ultra-short/low duration, and overnight and liquid funds come with shorter maturity periods. This makes them less prone to interest rate risk, which leads them to offer higher capital protection than funds that have longer maturity periods. 

Overnight and liquid funds have the potential to yield higher returns than savings bank accounts, whereas low, short and ultra-short duration funds have the potential to yield higher returns as compared to fixed deposits of the same tenure. Those looking to avail higher degree of capital protection should consider short term debt funds with highest exposure to sovereign debt instruments and AAA-rated corporate bonds. 

Short term debts funds are more tax-efficient than fixed and recurring deposits for investors that fall in higher tax brackets, with investment horizons of over 3 years. Returns booked on redemption of investments after 3 years are considered long term capital gains and are taxed at the rate of 20 per cent with indexation benefits. Returns booked on redemption of debt mutual funds within 3 years of investments are considered short term capital gains and are taxed according to the investor’s tax slab.

Bank Fixed Deposit

Bank fixed deposits provide a higher degree of capital protection and income certainty. The depositors continue to earn interest as per the booked rate regardless of any change in the fixed deposit rates. Bank fixed deposits opened with scheduled banks are also protected from bank failures through the deposit insurance program provided by the DICGC, an RBI subsidiary. The insurance cover is provided on cumulative deposits (including fixed, recurring, current and savings accounts) of up to 5 lakh per depositor.

Currently, the highest fixed deposit rates offered by some private sector and small finance banks range between 6.00-7.25 per cent per annum, nearly 175-230 bps higher than the highest fixed deposits rates offered by large private and public sector banks.

Most bank fixed deposits charge a premature withdrawal fee of up to 1 per cent on closure of fixed deposits before maturity. This penalty is deducted from the effective interest rate, which is generally lower than the booked fixed deposit rate and the original fixed deposit rate for the period that it has been in force.

Recurring Deposit

Recurring deposit is a variant of fixed deposits, where in the depositors deposit fixed amounts every month for a predetermined tenure. Regular monthly deposits instill financial discipline among depositors and also allow them to build financial corpuses over a period of time. Most banks offer the same interest rates for their recurring and fixed deposits for the same tenure. 

Depositors should note that banks penalize late depositing of their monthly installments. Similar to fixed deposits, recurring deposits too allow premature withdrawals in lieu of penalty. The interest incomes earned through recurring deposits are also taxable as per the tax slab of the depositor.

High Yield Savings Account

Savings accounts are usually used by the depositors to park their short term surpluses before using them for investments or expenditure heads. Most of the banks offer a low rate of interest on their savings bank account, generally in the range of 2.9 per cent and 4.75 per cent per annum for deposits within Rs 1 lakh. However, some private sector and small finance banks have started offering higher interest rates on their savings account deposit. The interest rate of such savings accounts can range anywhere between 5 per cent and 6 per cent per annum Higher interest rates, excellent liquidity and the availability of deposit insurance cover from the DICGC make high yield savings accounts an excellent tool for risk averse investors for parking their short term surpluses as well as their emergency funds.

As far as taxation is concerned, Section 80TTA allows savings account depositors to claim a tax deduction of up to Rs 10,000 on the total interest income earned from their savings account. However, interest income exceeding Rs 10,000 is taxed as per the depositor’s tax slab.

Corporate Fixed Deposit

Corporate fixed deposits are issued by NBFCs, HFCs and other financial institutions. Their interest rates are usually higher than bank fixed deposits and stay fixed throughout the booked term. However, unlike fixed deposits opened with scheduled banks, corporate fixed deposits are not covered under any deposit insurance cover. Hence, investors with lower risk appetite should prefer corporate fixed deposits offered by the companies with AAA ratings. Note that, like bank fixed deposits, corporate fixed deposits charge a premature withdrawal fee and their interest incomes are taxed as per the tax slab of the depositor.

The author is the Director of Paisabazaar.com