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How do you manage the risk of not achieving your short-term goals?

The life goal, such as the one above, needs to be converted into a “financial goal” for it to see daylight. This means talking about sobering facts about money and how to save enough of it to buy the flight ticket, book an Airbnb and still leave enough to do some kilt shopping and, you know, eat and drink, and make merry.

I have always wanted to visit Scotland and shout “freeeedommmmm” from the top of one of the many grassy hills that make up the famed “highlands”. This is what adviser types call “life-goals” (while hiding a smirk).

The life goal, such as the one above, needs to be converted into a “financial goal” for it to see daylight. This means talking about sobering facts about money and how to save enough of it to buy the flight ticket, book an Airbnb and still leave enough to do some kilt shopping and, you know, eat and drink, and make merry.

Since this is something, I would like to do in less than 5 years, I need three things – an income, savings from that income, and finally a safe kitty to put those savings in. That kitty also better be something that grows my money a bit. Thankfully, I have an income and I have shown a remarkable ability to not spend all my earnings on Video games, which means I save.

Now, as a firm believer in the power (and convenience) of mutual funds I would like to consider a solution for my kitty that involves mutual funds.

Enter debt mutual funds

Debt mutual funds, seriously? 

Many of you who read pink papers and visit financial news sites would be wondering if I have lost my mind. Considering the hammering some debt funds have taken thanks to the ILFS and DHFL crisis, it would not be so strange to wonder. 

This, however, brings us to the crux of the issue. After all, how does one go about managing the risk of not meeting their short-term financial goals, like a trip you have been looking forward to?

#1. Equity is not for short term relationships

Let’s get one thing out of the way first of all. Going the equity mutual fund route for short term goals (less than 5 years) is not smart. Equity is volatile and you don’t want the risk of markets entering one of their depressive phases just when you are planning to withdraw money for your goal.

Chasing returns much beyond inflation in the short term is a reason why many end up with bad investments. In the short run, it’s much more about “safety first” or in the case of investments “stability and capital protection first”. 

#2. It’s not so much about returns when it comes to short term goals

Chasing returns much beyond inflation in the short term is a reason why many end up with bad investments. In the short run, it’s much more about “safety first” or in the case of investments “stability and capital protection first”. 

The price of choosing stability and safety is a lower rate of return which in a best-case scenario would be perhaps 1%-2% above inflation

#3. Remember to Invest enough

Your savings rate matters much more over shorter timeframes and will do most of the heavy lifting. This means you need to plan to save from your income at least 90% of the goal amount. The rest can come from investment returns. The returns for good liquid funds, in most cases, is about 6%-7%. In 3 and a half years, a Rs 10,000 SIP in a liquid fund should lead to a corpus of about Rs 4.8 Lakhs of which the gains component will be about Rs 50,000-55000. 

#4. Not all debt funds are equal

Debt funds like ice creams come in many flavours. Some are far more stable than others and the debt instruments they own also reflect this. It would not be too far from the truth to say that understanding debt mutual funds can be more complex than understanding equity mutual funds.

Debt mutual funds are perceived to be “safer” while everyone “knows” that equity mutual funds, no matter the type, are volatile and since they invest in stocks come with a certain level of risk attached. 

There is a category of debt funds called credit risk funds that offer higher returns by investing in debt that the more cautious lenders want no part of. It would be a safe bet to say that these kinds of debt funds don’t make a safe harbour for your short-term money.

The least volatile debt funds are liquid funds or overnight funds. Because the underlying instruments tend to mature in months and are “liquid” as they are bought and sold frequently, they offer much more stability and far less excitement. These are the kinds that make more sense if you are allergic to volatility.

If your amounts are small, and the interest earned is less than Rs 10,000 a year then, even FDs might make sense, provided they are with a good bank. 

To sum up, reaching the short-term goal amount will depend much more on how much we can save.  Investing those savings in a stable investment such as a liquid fund or perhaps a good ultra-short-term debt fund, is simply a smart second step. That is how we can get to the goal amount while managing risks that are not under our control.

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