How To Invest In MF When Your Time Horizon Is Less Than 5 Years

By | May 21, 2015


The biggest question you have to answer yourself when you are investing is: “What is the time horizon for my investment?” This helps your financial advisor in suggesting you the right asset and product.

Uljhan Singh had to change his job and he got a fat cheque of Rs.5 Lakhs from his previous employer towards various perks like unclaimed leave and expense reimbursement. Now he wanted to put this money in bank FD but went to his friend Kent, a financial advisor for an expert opinion.

Kent, after listening to Uljhan suggested: “As you said you need this money for your daughter’s marriage, which could be anywhere between 6 months hence and 5 years, only a mixture of liquid funds, MIPs and arbitrage funds can help you, but not an FD.”

Uljhan Singh was shocked. “What? Mutual Funds? But, last time, you had said that mutual funds are only for time horizon of 5 years and above! And, now you are suggesting mutual funds!”

Kent laughed and said: “Arrey Uljhan Bhai, what I had said was in reference to equity mutual funds. Not just you, majority of people equate mutual funds with equity. There is more to mutual funds than just equity.”

“Really?” exclaimed Uljhan. “Can you elaborate a bit?”

“Okay. Let me start with Liquid Funds.”

Liquid Funds

Liquid Funds are funds which invest primarily in call money markets, treasury bills, certificate of deposits and commercial paper. Since they invest in instruments with high credit ratings, there is very low risk.

And, even after attracting a Short Term Capital Gains Tax at your Income tax slab, liquid funds give better returns than SB on post tax basis (7% to 9% for the past 3-4 years). Liquid Funds have no exit load too.

So, till you decide where to park your money, instead of putting in an SB account, invest it in liquid funds.

Ultra Short Term Funds

If your time horizon is slightly longer than 3 months but say less than 12 months, you can look at Ultra Short Term funds (earlier known as Liquid Plus Funds).

These funds are more volatile than liquid funds but can generate better returns. But these attract exit loads and are slightly volatile though not as much as Income Funds.

Income Funds

But, do note that for any investment which has a horizon of more than 12 months and say, up to 3 years, you can consider income funds. Income funds give higher returns compared to Liquid Funds, but they tend to be volatile and are definitely not for low risk people. They invest in combination of bonds, commercial paper, gilts, corporate bonds, etc.

A word of caution: they are very volatile and have exit loads, so be careful about your investment horizon. But yes, they are definitely lower than the penalty imposed by banks in case of premature withdrawal.

Gilt Funds

“Kent Bhai, I have heard that there is a debt fund category called gilt funds which invests only in government securities. I will invest in them, as capital safety is guaranteed,” says Uljhan.

Kent laughed: “Don’t have such presumptions, Uljhan Bhai! Even gilt funds can deliver capital loss in case of rising rates. Yes, the default will be nil but you need to have a longer time horizon to ensure that you do not lose your capital.”

Fixed Maturity Plans (FMPs)

Another option for you is the Fixed maturity Plans. FMPs are like fixed deposits wherein your money is invested in fixed income instruments with good rating and are more tax efficient than FDs due to indexation benefit.

Moreover, with FMPs you will not only get stable visible returns but also lock your money at higher rates. FMPs are extremely safe too.

Monthly Income Plans

Don’t get confused with the name ‘monthly income plan’. They do not guarantee any income on a monthly basis. MIPs have the potential to deliver higher inflation adjusted return due to their marginal equity exposure of 10% to 25%.

So, if you are okay with a bit of equity risk, then you can surely look at these MIPs as these have potential to give you double digit returns, especially if your time horizon is more than 3 years.

Arbitrage Funds

One category that is ignored but most important is arbitrage funds. These funds are treated like equity funds and give returns on par with liquid funds. In fact, the effect of market drops is little to nil on this category. Arbitrage funds have given post tax returns in the range of 8% – 9%.

You can consider investing in arbitrage fund with dividend option and then switch the dividend into a balanced or large cap fund. This should give you tax free return in excess of double digit for your time frame of 5 years.

Finally, all these debt MFs are held for 3 years, so indexation benefit is allowed wherein you will be taxed only for the returns earned over and above the inflation rate. And arbitrage funds are treated as equity funds and there are no capital gains if held for 1 year or more.

Use liquid funds for your contingency reserves and very short term investment.  Give high weight age to credit ratings of the instruments that these debts funds have invested in and also their expense ratio which could affect the overall returns.

Do note, the returns of debt funds including arbitrage funds will be volatile on day to day basis.

Finally, “the good news, Uljhan Bhai, the best time to invest in duration funds like the gilt funds or income funds is when the interest rates are expected to fall.”


YOU MAY ALSO WANT TO: Find out your returns – SIP Calculator

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