Short-term Investments: How They Work, Definition and Example

Short-term goals are those that are expected to occur or be fulfilled in the near future. Short-term investments are the usual preferred mode when it comes to meeting short-term goals. Such investment options are classified as those which have a tenure of 3-5 years.

What Are Short-Term Investments

Short-term investment options are comprised of marketable securities that can easily be converted into cash in hand. These securities can be debt instruments or equity, or a mix of both.

When it comes to fulfilling short-term goals, easy liquidation of funds is an important criterion; these funds are necessary to meet expected expenses.

Do note that since time is of the essence, short-term investments, by a rule of thumb, need to be less risky than long-term investment options. This also means that short-term investments usually have a short tenure and thus tend to generate predictable returns.

How Short-Term Investments Work

Short-term investments are designed in such a way that they safeguard the principal amount while generating returns; that can be converted into usable funds after a few years. This is one of the primary advantages of short-term investment options. That they are highly liquid, and you can get your money quickly when you need it.

While short-term investment plans contain lower risk than long-term investments, they may not provide higher returns than compared to long-term investments. Also, when you invest for the short-term, your choice bouquet is limited to only certain types of investments.

What makes a good short-term investment?

Good short-time investments will contain a few major attributes.

• The minimum investment size shall be reasonable. This means you can start an investment with as less as Rs 500
• Good short-term investments shall offer you convenience while opening and closing.
• They shall offer safety of capital/principal and can offer relatively decent returns.
• Short-term investment plans with high returns invest your funds in safe, marketable securities that can be liquidated quickly.
• A good short-term investment shall not burden you with high costs/charges.

 

Tips for investing money for five years or less

While there is no perfect time to start investing, here are a few tips to invest:

• Start by defining your goals. You should think about your financial goals and break them down into categories based on the available time frame or time you can allocate to achieving them.
• Since their goals are short-term in nature, it makes sense to consider short-term investments to achieve them. Because of the paucity of time and lower risk appetite with regard to short-term investment, it is important to make the right invesetment.
• Understand the rate of returns. Expect a reasonable rate of return that beats inflation. Keep your return expectations grounded to have a smooth short-term investing experience. Returns alone should not guide your short-term investment options. Instead, capital protection should be the foundation.

 

Short-term investment options:

Savings accounts

A traditional favourite, savings accounts offer one of the easiest and safest ways to save and invest your money in terms of short-time investments. The main motive in savings accounts is liquidity. Depending on the bank you may receive anywhere betweer 2 percent to 7 percent annual returns from savings accounts. Of course, every bank has its terms and conditions and the returns may vary based on them.

Liquid Funds

An emerging choice for many, liquid funds are becoming popular short-term investments. Liquid funds invest your money in short-term government certificates and securities of deposits. This is essentially a place to keep your emergency funds. Money is accessible 24X7, and it can take just a few days to redeem your short-term investments. Returns from liquid funds are subject to market risks and are, annualized and pre-tax on liquid funds investment.

Short-term funds

A notch above liquid funds, short-term funds put your money in securities that mature in 1-3 years. These funds are a little riskier than liquid funds. In market parlance, they are called ultra-short-duration term funds. If you choose to invest in short-term funds, understand that these are market-linked schemes and like any other market-linked scheme, returns are not guaranteed.

Recurring deposits

This type of short-term investment is suitable for those who don't want to invest in a lump sum. Recurring deposits allow you to invest small sums every month. You have two options here: Postal Office RD or Bank RD. Pre-tax return in recurring deposits revolves in a wide range and depends on the selected bank or Post Office interest rate being offered over the period.

National Savings Certificate

This is a Post Office product and is offered for a tenure of 5 years. Such a short-term investment is suitable if your target goal is exactly 5 years away. While investing in NSC, you can claim tax benefits under Section 80C. It currently offers a 7 percent pre-tax return.

Arbitrage funds

These mutual funds offer additional tax efficiency if held for more than a year. They fall into the hybrid fund category. Historical rates of return show 4-6.5 percent pre-tax return.

Fixed maturity plans

Coming with a lock-in period and like bank FDs, Fixed Maturity Plans offer more tax efficiency, and there can be some outlook on returns that are entirely market-linked in nature. These invest in reasonably safe debt instruments, not putting your capital at risk.

Frequently Asked Questions

How long does a short-term investment last?

It could range between 1 day to 5 years, as per the product tenures of available short-term investment options.

Is short-term investing a good idea?

Short-term investing is a need for many investors who cannot commit to long-term investment due to limitations on their investment horizon.

What are the risks of short-term investments?

Short-term investments, generally, have low risks and tend to safeguard the principal amount.

Is short-term gain taxable?

Yes, short-term capital gain taxes do apply to short-term investments. The taxation varies as per specific products and existing tax laws.

Where to invest money for the short-term?

Depending on your exact requirement, i.e., need, risk profile, liquidity, returns, and convenience, there are a whole host of short-term investment options for you to try. Some common short-term investment plans are savings accounts, recurring deposits, debt funds, government securities, etc.