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How to link debt mutual funds to your short term goals?

For goals that are going to take less than five years, fixed income makes most sense. These can include debt mutual funds, fixed deposits, Government and private bonds, NCDs, various post office schemes, and a few others.


In this article we will talk about short term goals and how you can link mutual funds to them. We have discussed the first four goals here.

For goals that are going to take less than five years, fixed income makes most sense. These can include debt mutual funds, fixed deposits, Government and private bonds, NCDs, various post office schemes, and a few others.

The idea is to minimise volatility and earn better returns than what letting money simply sit in bank accounts will allow. At best you want to match inflation here rather than try to beat it as the impact of inflation will be minimal.

You wouldn’t lend to people you don’t trust, right? So how would you know that the organisations you lend to are trustworthy? This is the main challenge when investing in fixed income. The default option is to trust your bank (yes, even a savings bank account means you are lending them money) or the government.

Why mutual funds for these goals?

Investing in fixed income means investing literally in loans. You are basically lending your money, directly or indirectly to organisations. These can be the government when you invest in government bonds or G-secs and the like. When you invest in NCDs, commercial paper or the like, you are lending to corporate entities.

You wouldn’t lend to people you don’t trust, right? So how would you know that the organisations you lend to are trustworthy? This is the main challenge when investing in fixed income. The default option is to trust your bank (yes, even a savings bank account means you are lending them money) or the government.

But there are different challenges here, apart from trust. Most debt is repayable only when it comes due. Getting your money when you want to may not be feasible, even if you get interest payments. Talking about interest, as you might know interest rates change every so often. This has a major bearing on the price of debt instruments. It wouldn’t be too much of stretch to say that investing in fixed income can be more complex than even equity.

Debt mutual funds solve problems of trust, liquidity, and duration. For the most part, debt mutual funds invest in debt of reliable entities, allow you to withdraw and invest as per your convenience and generate returns ( 6%-7% in case of liquid funds and 8%-8.5% in case of short term debt funds) that make sense for short term objectives. 

What kind of mutual funds would make most sense for most people?

Debt mutual funds come in many types based on the quality, duration, type, and interest of their fixed income investments. For most individual financial goals which are due in the next 5 years or less, liquid funds and short duration debt funds that invest in high quality debt are most suitable.

A portfolio made up of the two types can provide the right mix of stability and returns keeping in mind the appropriate financial goals. For example, if you are saving for a vacation in the next two years, then a good liquid fund is ideal for such a goal. 

If the goal needs more than three but less than five years, there are short term debt funds you can look at that offer slightly better returns than liquid funds but can be more volatile. Debt mutual funds also offer tax efficient returns, especially if you hold them for three years or more,  as you get the benefit of indexation. This is quite useful if you are saving big amounts.

The takeaway here is that for short term goals, choose reliable short duration debt funds which invest in high quality debt investments, and have high liquidity. 

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