Short-term investments of up to 3 years need greater emphasis on capital protection than generating higher returns.
Investing for short-term financial goals requires different investment strategies than those required for attaining long-term financial goals. Short-term investments of up to three years need greater emphasis on capital protection than generating higher returns, given that shorter investment horizons have lesser time to recover losses from market corrections (if any). Let’s look at five short-term investment options with higher capital protection, liquidity and income certainty features.
Bank Fixed Deposit
Bank fixed deposits (FDs) guarantee principal repayment and interest income at booked rate of interest, regardless of any change in card rate during the tenure. They are also covered under the deposit insurance program provided by Deposit Insurance and Credit Guarantee Corporation (DICGC). This insurance covers fixed deposits along with deposits in your current, savings and recurring deposit accounts for up to 1 lakh per depositor, per bank in case of bank failure. However, it is only applicable to banks included in the Second Schedule of the RBI Act.
At present, small finance banks offer highest FD rates of up to 9% p.a. The highest interest rate offered by public sector banks and private sector banks can go up to 7.25% p.a. and 8.50% p.a., respectively. Senior citizens get concessional rate, which can be up to 0.75% above these interest rates depending on the banks.
On the flip side, interest earned on your bank FDs is added to your income and taxed according to your tax slab. Bank fixed deposits also attract premature withdrawal penalty of up to 1% on closing it before the end of the tenure. The penal rate is deducted from effective interest rate, which is either the original card rate or contracted FD rate for the period for which the bank FD has been into force, whichever is lower.
Corporate/Company Fixed Deposit
Corporate/Company FDs are issued by HFCs, NBFCs and other financial institutions. While their interest rates are usually 1% higher than average bank FDs, they are unsecured deposits with no deposit insurance cover as in the case of bank FDs. However, one can get a rough idea about their safety by referring to credit ratings assigned by different credit rating agencies. These credit rating agencies rank corporate/company FDs on the basis of the issuer’s capacity to service interest and principal component. The higher the credit rating, the safer is the instrument.
Just like bank FDs, corporate/company FDs also levy premature withdrawal penalty and their interest income is taxed as per your tax slab.
Recurring Deposit (RD) is just a variant of fixed deposit where you can deposit fixed amount at regular monthly intervals for a fixed tenure. Most banks offer same interest rates on RDs as on their FDs for similar tenure. Like bank FDs, senior citizens get concessional rates on RDs above these interest rates depending on the bank. With provisions for automatic deduction of your monthly RD instalments from your savings bank account, it can assist in inculcating financial discipline and ensure regular investing for those with regular investible surpluses. However, remember that banks levy penalty on late deposit of monthly instalments. Like FDs, premature withdrawals of RDs are allowed only in lieu of surrender charges/penalties and the interest income earned is taxable according to your tax slab.
High Yield Savings Account
While savings accounts are generally associated with low rate of interest ranging between 3% and 4% p.a., some small finance banks and private banks have started offering higher interest rate on their saving accounts. Currently, interest rates of saving accounts can go up to 7.25% p.a. Their higher interest rate, high liquidity and deposit insurance cover from the DICGC makes them a prudent option for low risk investors for parking surplus and emergency fund.
You can also claim tax deduction of up to Rs. 10,000 on interest income earned on savings account as per Section 80TTA. However, interest income exceeding Rs. 10,000 gets taxed as per the tax slab.
Short-term debt funds like liquid, low duration, ultra-short duration and short duration funds have shorter maturity profiles. Their shorter maturity period makes them less susceptible to interest rate risk. Hence, these funds have higher capital protection feature as compared to longer maturity profiles. For instance, liquid funds invest in debt and money market securities with maturity of up to 91 days, ultra-short duration funds invest in those with maturity between 3 and 6 months, low duration funds invest in those with average maturity between 6 and 12 months and short duration funds invest in those with average maturity between 1 and 3 years. As they are market-linked, these funds also have the potential to generate higher returns than FDs of the same tenure. Also, liquid funds, ultra-short duration funds and most of the low duration funds do not charge any exit load and hence, offer higher liquidity than corporate and bank fixed deposits.
As far as taxation is concerned, the gains booked within 3 years of investment is termed as short-term capital gains and taxed in accordance to your tax slab. Those booked after 3 years are termed as long-term capital gains and taxed at the rate of 20% with indexation benefits.
(The author is Director & Group Head – Investments, Paisabazaar.com)