Understanding the value of investment is an essential component of financial planning. Investing not only helps to accumulate money but also to battle inflation. However, many people ignore the importance of short term investments. This type of investment is critical because it offers the potential for rapid profits and serves as a safety net during financial catastrophes.
For example, say you have an unexpected medical bill or want fast funds for your child’s school fees. Short term investments can help in these situations. Another example may be preparing for a vacation or purchasing a car in the near future. Short term investments can help you attain these objectives without jeopardising your long-term financial aspirations.
Diversification of your investment portfolio with short term investments is vital for the following reasons –
Risk management
The short term investments are less risky than the long-term ones. This is because they tend to be less susceptible to market fluctuations. Owing to the incorporation of short term investments into your portfolio, you can reduce the risk of long-term investments.
Liquidity
Short term investments are highly liquid. This implies that you can transform your investments into cash whenever you need to. This is especially critical when it comes to financial crises.
Now, let’s take a look at the top ways you can diversify your portfolio with short term investments –
Savings account
The savings account is an account provided by banks which has a high degree of liquidity and is a short term investment. The benefit is that capital is secure, and withdrawal is not difficult. Interest rates differ from one bank to another, but they can range from 3% to 6% per annum. It is the best form of investment for parking emergency funds, and the interest obtained is added to your income and taxed accordingly.
Recurring deposits
RDs are a type of time deposit where a certain amount is deposited at regular intervals, namely monthly intervals. The maturity period can be 6 months or up to 10 years. The interest rates are similar to FDs and the interest income is taxable.
Fixed deposits (FDs)
FDs are investment instruments offered by financial institutions with maturity periods spanning from 7 days to 10 years. They pay higher interest rates than savings accounts, so they are an attractive short term investment for investors. The interest earned is taxable at a rate depending on the individual’s tax bracket.
Liquid mutual funds
These are mutual fund schemes that invest in short-term debt securities and money market instruments. Such funds are considered one of the best investment plans in India as they come with low risk and no lock-in, get better returns than savings accounts, and the profits are taxed as income tax slabs.
Short term debt funds
These mutual funds invest mainly in corporate bonds and government securities with a maturity period of 1-3 years. They have a higher return than traditional FDs and are appropriate for investors who are ready to take some risk but not high.
Ultra short-term funds
Ultra short-term funds engage themselves in debt and money market instruments that have a maturity of about 3-6 months. They provide higher returns compared to liquid funds and are appropriate if the investment horizon is a few months. Nevertheless, they are a bit riskier than liquid funds.
Arbitrage funds
Arbitrage funds make a profit by exploiting the price gap between the cash and derivative markets. They are considered safe as they hedge their positions and can give better post-tax returns.
Corporate fixed deposits
The bank FDs are term deposits with the bank that offer a higher rate of interest than the corporate FDs. But in comparison, corporate FDs have higher risk and no deposit insurance.
Money market funds
These funds invest in highly liquid instruments like treasury bills, commercial papers, etc. with a maturity period of up to one year. They provide average yields, and they are suitable for conservative investors who need to earn more than a savings account.
Sweep-in FDs
In Sweep-in FDs, this extra amount in the savings account is automatically transferred to an FD, thus earning more returns in the form of interest constituents. They can be withdrawn at any time, thus combining liquidity and better yields.
Treasury securities
These are government-backed securities with guaranteed returns and varying maturity periods. They are great for cautious investors as they pose almost little credit risk.
Gold ETFs
Gold ETFs are similar to physical gold, with each unit being equal to 1 gram of gold. They can be traded on stock exchanges, providing high liquidity. They are best suited for investors looking to invest in gold without worrying about storage issues and theft.
Certificate of deposits
These are unsecured, negotiable, short term investment instruments issued by banks having a set maturity date. They provide better yields than savings accounts but need a lock-in period during which no withdrawals are permitted.
Bonds
Bonds are debt instruments in which the issuer agrees to pay the investor a specified interest rate at regular intervals and repay the principal amount at maturity. Short-term bonds have a maturity of one to five years and can be issued by both the government and private corporations. They provide consistent returns and are suitable for cautious investors.
Commercial papers
Commercial papers are unsecured short-term loan instruments issued by businesses to address immediate financial requirements. They provide large yields but pose a higher risk because they are unsecured.
Ending note
To summarise, diversifying your portfolio with short term investments is critical for risk management and liquidity. It offers a balanced investing plan that will help you reach your financial objectives while remaining stress-free. Remember that the key to effective investing is not only gaining money but also safeguarding what you’ve gained. Diversification of investing in short-term securities is critical in this situation.
Thus, it is critical to strategise your investment portfolio, balancing it with a combination of long-term and short-term assets. While long-term investments strive to build wealth for future aspirations, short term investments guarantee that you are prepared for unforeseen financial requirements while still safeguarding your cash and making acceptable returns. Finally, diversifying your investment into short-term assets exemplifies the adage “don’t put all your eggs in one basket,” resulting in a well-rounded, adaptable, and robust financial plan.
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