It’s true that investing in equity assets like stocks and mutual funds will help you earn tax-efficient inflation plus returns in the long run, but that does not mean you have to put all your eggs in the equity basket.
Your financial and life goals come with timelines and usually, you want the highest return in any timeline. However, equity investments are most suitable for longer period goals, say those which are 7-10 years away or more. For short to medium term goals you are better off relying on debt investments or you could even combine that with some equity.
For the money, you need in less than a year
For short period you might think that simply leaving it in your bank account is good enough. Why take on the headache of investing just for 2 or 3 months? This could be for a down payment on a housing loan or paying your child’s annual school fees and so on. Usually, the value of money needed in the near term is fixed and there isn’t much leeway for accepting anything less than required.
Plus, there isn’t enough time for compounding returns and hence, one feels why to make the effort of keeping the funds out of the bank account.
However, by leaving money in the bank account you risk the temptation of spending it. Plus, without compromising the stability of returns, you can earn better tax-adjusted returns by putting this money in short term liquid funds.
You have the flexibility of redeeming whenever you need the money.
For the money, you need anywhere between 1 to 5 years
This is a trickier time period to manage. It’s neither too short nor long enough. Determine whether the goal value in this period is flexible or fixed. For example, let’s say you decided to buy a particular car after two years, the value of the vehicle is known and fixed; for this goal your amount is non-negotiable.
You have another goal of travelling across India for a month and that will culminate in three years. While you have a rough idea of the minimum required for the second goal, but the upper limit is not fixed.
The goal for buying a car is better served by assigning debt investments. For the second goal, invest using a combination of debt and equity in such a way that the former takes care of the minimum you want to receive and equity brings in the bonus. Three years is not a long enough time period for volatility in equity investments to smoothen out and deliver consistent returns.
Anything can happen in this period. If equity investments are managed well and the markets play along, you can make a positive impact on your holiday fund, else you will make at least the minimum required.
In this manner, for medium-term goals using a combination of equity and debt, depending on the defined payout and time period, can be useful.
If you leave it only in equity hoping for the best possible return, you may be disappointed with the volatility even closer to redemption. Always look for portfolio returns for such goals rather than relying only on one asset, especially if it is volatile like equity.