Short term investment options can be easily converted into cash. The tenure for these investments ranges from one day to 5 years. These investments are of high quality and are highly liquid. They best suit investors with low understanding of risk and expect predictable returns. In this article, we have covered the best short term investment options in detail.
What is a short term investment?
Short term investment options are those marketable securities that can easily be liquidated into cash within five years. Also, these temporary investments are mostly used for parking excess funds for a short period. Short term investments are highly liquid and hence are used by investors to meet expected near future expenses. Short term investments are less risky than long term investment options. This is because these investment products have a short tenure and give predictable returns.
Few of the short term investment options are high yielding savings accounts, recurring deposits, debt funds, and government securities. These are the most popular short term securities with a tenure of a few months to 1 to 2 years. Apart from these, the other short term investments with investment tenure up to 5 years are bank fixed deposits, post office time deposits, national savings certificate, and large-cap mutual funds.
Short term investments also mean the financial assets that are listed under the current assets of the balance sheet. These assets are considered short term investments as they can be liquidated into cash within 12 months.
How short term investment works?
Short term investments are those securities that can be easily converted to cash. The primary goal of short term investments for both individuals and corporates is to protect capital and at the same time, generating returns. Short term investments offer higher returns than a regular bank savings account. Hence investors can park their excess funds in these investments and earn a higher return. Investors with a short term investment horizon of 1 month to 5 years can invest in these securities.
For corporates, short term investment plans help in earning additional income to meet their working capital requirements. Companies with good cash balance can afford to invest in short term investments. Usually, companies park their excess funds for a tenure ranging from 1 day to 12 months. All the investments that they make are highly liquid and can be converted into cash easily. Since the short term investment gives predictable returns, they are considered as high-quality, low-risk investments.
Furthermore, investors can also park their surplus cash to meet their short term goals. Short term goals such as buying a vehicle, going on a vacation or buying jewellery can be realized by investing in these schemes. Instead of holding idle cash for a short duration, one can invest in short term investment plans and generate some returns.
Following are the different types of short term investments.
A savings account is a popular investment option that is preferred by many individuals. Most individuals find it easy and convenient to hold money in a savings bank account. A savings account is usually held with a bank or any other financial institution. The depositor deposits money and earns interest on the deposit amount. These accounts are known for their liquidity, as one can withdraw the money whenever they want.
The interest rates for savings accounts vary from institution to institution. The rates range from 3.5% to 7% per annum. Also, there is no limit with respect to the deposit amount, and many banks offer zero balance savings accounts.
Bank fixed deposits
Bank fixed deposits are one of the popular short term investment options as they offer guaranteed returns. These are also the safest investment options. The returns on bank FDs are fixed and don’t change with market movements. Banks offer a 3-7% return on FD investments for varying tenures. Moreover, senior citizens get preferential FD rate. Investors can calculate their potential returns from FDs using a fixed deposit calculator. The tenure for a bank FD ranges from 7 days to 10 years. Also, investors can choose from the existing tenure options offered by the bank.
One can also renew the bank FD once it matures. One can prematurely withdraw their Bank FDs before the maturity period. Hence are considered as liquid investments. Investment in tax-saving FDs offers tax benefits up to INR 1,50,000 per annum under Section 80C of the Income Tax Act, 1961. The interest is taxable as per individual investor’s income tax slab rate. Moreover, if the interest income exceeds INR 40,000 per annum (INR 50,000 for senior citizens), the bank will cut TDS at 10% (20% if PAN Card is not submitted). One can use an income tax calculator to estimate their tax liability.
Recurring deposits are also a type of short term investment options offered by banks. A recurring deposit allows the depositors to invest monthly. The scheme offers benefits such as guaranteed returns, liquidity and flexibility. The interest rates of recurring deposits are revised from time to time. Also, the rates vary between banks. Investors can calculate their potential returns from RDs using a recurring deposit calculator.
RDs are considered as a low risk and also profitable investment option. The tenure of an RD ranges between 6 months to 10 years. However, RDs have a lock-in period of 1 month. Furthermore, in case of premature withdrawals within one month, no interest is paid on the deposit.
Returns from the deposits are added to the investor’s income and are taxable as per the Income Tax slab rates. Moreover, in case the interest on the deposit amount exceeds INR 10,000, the bank cuts TDS of 10% when a pan card is submitted. And, 20% TDS is cut when the depositor doesn’t submit the PAN card.
The Government of India issues treasury securities. One can consider these for short-term investing. Also, securities offer high safety, liquidity and offer decent returns. Furthermore, they are issued at a discount to their face value and are redeemed at the nominal value. Therefore, investors earn from the difference between the two prices.
Also, the returns from treasury bills are lower than debt funds. However, these are safe investment options to earn decent returns. The maturity dates of these securities vary between 91 days to 365 days. Furthermore, the thumb rule of T-bills is such that shorter the maturity period, lower are the returns from the security.
T bills are zero-coupon bonds. Therefore, these do not earn any interest. The investor earns from the difference in the issue price and face value. Hence, the returns from the T-bills are fixed and are not affected by market and economic conditions.
Debt mutual funds are a type of mutual funds that primarily invest in a government bond, debt and money market instruments, and corporate bonds. In comparison, to other types of mutual funds, debt funds are considered to be safe. Hence, they are ideal for risk-averse investors and also for investors seeking good returns over a short period of time. Furthermore, debt funds are not very volatile against the economic and stock market fluctuations. Following are the three categories of debt funds:
- Liquid Funds: Liquid funds invest in debt and money market instruments with maturity up to 91 days. For short term investing, these are may be ideal.
- Low Duration Funds: Low duration funds have a Macaulay duration ranging between 6 to 12 months.
- Ultra Short Duration Funds: These are funds with Macaulay duration ranging between 3 to 6 months
Gains from debt mutual funds are taxable on the basis of the holding period. For investments withholding period less than three years are taxable at Short Term Capital Gains Tax (STCG). These gains are added to the investor’s taxable income and are taxed at the slab rate. For all investments held for more than three years, the gains are taxable at Long Term Capital Gains Tax (LTCG) rate of 20% with the benefit of indexation.
Large-cap mutual funds are mutual funds that invest in equity and equity-related investments. These funds invest in large-cap companies. Large-cap companies are those companies that rank between 1-100 in terms of market capitalization. Large-cap mutual funds historically gave a 10-12% return per annum. However, since these funds majorly invest in equities, their returns are market-linked and hence aren’t guaranteed.
These funds best suit investors with an investment horizon of 3-5 years. Large-cap funds not only offer good returns but are also highly liquid. Investors can redeem their investments whenever they want. Large-cap mutual funds are low risk investments as they invest in large-cap companies. These companies are well established corporations that have strong fundamentals and have achieved economies of scale. Also, returns from large-cap funds are taxable. If the investment is redeemed within one year of investment, then the short term gains are taxed at 15%. If the investment is withdrawn after one year, then the gains are called long term capital gains. These are taxable at 10% if the gains exceed INR 1 lakh.
Post Office Time Deposits
Post Office Time Deposits or Post Office Fixed Deposits are one of the most traditional savings schemes in India. Indian Postal Services offer it. These are similar to bank fixed deposits where investors invest a lump sum amount for a fixed period of time. The interest rate on POFD ranges between 6.6%-7.4%. Since the Government of India backs this scheme, the returns are guaranteed. The tenure for POFDs is fixed, and they come in 4 different tenures, 1 year, 2 years, 3 years, and 5 years.
The minimum investment for this investment option is INR 200 and thereafter in multiples of INR 200. Hence this is considered as the most accessible short term investment option. One has to hold POFDs until maturity. However, the post office allows premature withdrawal of the time deposits after 6 months from the date of investment. Moreover, the post office also charges a penalty of 1% for premature withdrawal. Furthermore, one can also take a loan against POFD. Hence, these are considered as moderately liquid investments. Investment in POFDs is eligible for tax deduction under Section 80C of the Income Tax Act. Investors can get a tax benefit on investments up to INR 1,50,000 per annum. And the interest is taxable at an individual’s income tax slab rates. Also, one can use an income tax calculator to estimate their tax liability.
National Savings Certificate
National Savings Certificate is a Government of India initiative that encourages small savings. Since the government backs the scheme, the returns are guaranteed. Hence it is a low risk investment. Currently, the scheme pays a fixed rate of interest of 6.8% per annum. The tenure of this savings scheme is 5 years. Investors can invest a minimum amount of INR 1,000 and thereafter in multiples of INR 1,000.
NSC ranks low on liquidity when compared to other short term investment options. This is because the scheme has no premature withdrawal facility. However, few banks allow loans against NSC. Investment in NSC qualifies for tax saving under Section 80C of the Income Tax Act, 1961. Since the interest is reinvested, the interest is free from tax for the first four years. However, in the last year, when NSC matures, the interest is taxable.
Comparison of each type of short term investment
|Type of Investment||Tenure||Return/Interest||Ideal for||Taxation||Liquidity|
|Savings Account||No tenure||3.5% to 7% p.a.||Investors seeking high liquidity||As per depositors Income tax slab rate||Highly liquid|
|Bank fixed deposits||7 days to 10 years||3%-7%||Risk-averse investors||As per investors Income tax slab rate||Moderately liquid|
|Recurring Deposits||3 months to 10 years||~6.5% p.a.||Investors who want to invest monthly||As per depositors Income tax slab rate||Highly liquid, however, has a lock-in period of 1 month|
|Treasury Securities||91 days to 365 days||The price difference between the issue price and face value||Risk-averse investors||As per investors Income tax slab rate||Highly liquid|
|Debt Funds||3 months to 12 months||~7-8% p.a.||Risk averse investors||As per investors Income tax slab rate||Highly liquid|
|Large-cap mutual funds||3-5 years||10%-12%, market-linked returns||Investors seeking good returns, with high liquidity||Short term capital gains at 15%,Long term capital gains at 10% (gains above INR 1 lakh)||Highly liquid|
|Post Office Time Deposits||5 years||6.6%-7.4%||Risk-averse investors||As per investors Income tax slab rate||Moderately liquid|
|National Savings Certificate||5 years||6.8% p.a.||Risk averse investors||As per investors Income tax slab rate||Low liquidity|