We all have dreams. We have financial goals. Say, you want a go a foreign holiday in the next three years. Or you want to buy a house and for that you need to arrange for down payment. If these goals are a few years away, you can plan for it well in advance. But how do you plan for a big expense just a few months or a handful of years away?
Task loaded with challenges
Though you are saving for short term, you cannot ignore some constraints. To begin with, you do not have much time on hand. Since the financial goal is due in near term, you cannot take risk. As you have to protect your capital, you cannot invest in stocks. Minimum investment time frame for investing in equity mutual funds should be five years.
Second challenge comes in the form of low interest rates on offer. Interest rates on various instruments are on the way down in line with the downward revisions in policy rates done by Reserve Bank of India. Repo rate, the rate at which RBI lends to commercial banks stands at 4% today as compared to 6% in April 2019. Most fixed income instruments such as bonds and fixed deposits have seen the rates on offer going down. For example, SBI fixed deposit offers 4.9 per cent rate of interest on one year fixed deposit compared to 6.8 per cent in March 2019.
Third and the most ignored factor is the tendency to use up emergency fund. Emergency fund – a corpus enough to pay for at least six months of expenses, insurance premium and equated monthly instalments, should not be used to pay for short term goals. Financial emergency such as loss of job can devastate your financial planning if you have already used up your emergency fund.
Set realistic expectations
Falling interest rates have ensured that there is little reward for savers. High inflation – around 6 per cent, ensures that the real rate of interest (nominal rate of interest minus inflation) are negative. “High inflation leaves limited scope for further cuts in policy rates by RBI,” says Mahendra Kumar Jajoo, CIO-Fixed Income, Mirae Asset Investment Managers (India). High readings on inflation and fiscal deficit are expected to put upward pressure on interest rates. But open market operations by RBI ensures that the rates remain benign. Interest rates should remain range bound, says Jajoo.
Joydeep Sen, Trainer, Author and Columnist also thinks that the rates are not in a hurry to go up. “Cancellation of government securities’ auction when the RBI received bids at higher yields than expected, is a clear indicator that the regulator wants to keep the rates low.”
Since the interest rates are expected to remain benign, the investors should scale down their expected returns on their short term investments.
You have to align your investment plans with your financial goals. If your target amount is high, then you cannot achieve it if you are saving small amounts. For example, to make a down payment of Rs 20 lakh for home purchase three years from now, you should be saving Rs 51600 per month, if you anticipate 5 per cent returns on your investments.
Where should you invest?
If you are taxed at low income tax rates, then you can go for traditional investment avenues. One year fixed deposits from good banks offer around 5 per cent, as seen earlier. If you have penchant for risk, then you can go for fixed deposits of private sector bank and small finance bank. For example, DCB Bank offers 6.75 per cent rate of interest for 15 months fixed deposit. For a one year fixed deposit Utkarsh Small Finance Bank offers 7.25 per cent rate of interest.
“High interest rates, however, come with high credit risk,” points out Joydeep Sen.
If you do not want to compromise on safety of your capital, but are willing to forego liquidity and have more than one year time frame, then you have options such as fixed deposits by top rated housing finance companies and fixed deposit with India Post. For example, HDFC offers 5.9 per cent on 15 months fixed deposit whereas HDFC Bank offers 5.1per cent. Similarly, time deposit with India Post for one year offers 5.5 per cent rate of interest. But these investments score low on liquidity, as premature withdrawal offer very low return.
If you are taxed at higher rate of slab and comfortable with market determined return, then you can consider investing in bond funds. Joydeep Sen recommends investing in bond funds that invest in high quality bond portfolios with maturities in line with your investment time frame.
“Short term bond funds should work for investors with 2-3 year time frame,” says Jajoo. However, if you have less than one year time frame stick to ultra short term bond funds. But make sure you monitor your mutual fund scheme’s portfolios regularly to ensure that your scheme has maintained its high credit profile.
Though you may want consider investments in arbitrage funds to enjoy long term capital gains on gains earned on investments held for more than one year, you should be prepared for low returns accompanied by volatility.
To put it simply, planning for short-term goals is a low risk path. Time is not on your side so make sure you limit the risks you take.