Meet Your Short-Term Goals

Short-term financial goals have investment horizons of up to three years. As short-term horizons endow lesser time to recover losses from market volatilities and corrections, if any, investments for shorter horizons should lay greater emphasis on capital preservation and income certainty than on yielding higher returns.

Here, I will list five short term investment instruments offering higher capital protection, income certainty, and liquidity features:

Short-term debt mutual funds

Short-term debt funds such as short-duration, ultra-short duration, low-duration, overnight, and liquid funds come with shorter maturity periods. Their shorter maturity profiles make them less prone to interest rate risk, which leads them to offer higher capital protection than debt funds having 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 a higher degree of capital protection should consider short-term debt funds with the highest exposure to sovereign debt instruments and AAA-rated corporate bonds. 

Short-term debt funds are more tax-efficient than fixed deposits and recurring deposits for investors falling in higher tax brackets, with investment horizons of over three years. Returns booked from the redemption of investments after three years are considered as long-term capital gains and are taxed at the rate of 20 per cent with indexation benefits. Returns booked on the redemption of debt mutual funds within three years of investments are considered as 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 during the fixed deposit’s tenure. 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 of each scheduled bank.

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

Most banks fixed deposits charge a premature withdrawal fee of up to 1 per cent on the 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 the fixed deposit has been in force.

Recurring Deposit

A recurring deposit is a variant of fixed deposits, wherein the depositor deposits fixed amounts every month for a predetermined tenure. Regular monthly deposits through recurring deposits instill financial discipline among the depositors and also allow them to build a financial corpus over a period of time. Most banks offer the same interest rates for their recurring deposits 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 allow premature withdrawals in lieu of the 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 p.a. for deposits within Rs 1 lakh. However, some private sector banks 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 and 6 per cent p.a. 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, Paisabazaar.com

DISCLAIMER: Views expressed are the authors' own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.