Investing for short term financial goals requires a different mutual fund approach compared to long term wealth creation. Short term goals are those that you want to achieve in 1 to 3 years like buying a car, home renovation, wedding expenses etc. Read on to know mutual fund meaning, along with some tips on selecting suitable mutual fund categories for such needs.
Define your time horizon
The first step is to have clarity on the specific timeframe you are investing for. Needs like an international vacation planned next year have a 12-month horizon. Saving for your child’s college education 2 years later has a 24-month horizon. Your investment choice should be guided by this defined horizon. Avoid equity funds if your timeline is less than 3 years.
Opt for ultra-short and low duration funds
Stick to debt mutual funds for short term needs, specifically the ultra-short and low duration categories. These invest in fixed income instruments of very short maturities like 3-6 months. Their portfolios have negligible interest rate risk given the small duration. You can opt for growth or dividend options as per your cash flow needs.
Consider dividend mutual funds
Dividend mutual funds are a type of mutual fund scheme that provides regular income in the form of dividends to investors, in addition to capital appreciation. The tax efficiency, income payouts, low volatility and flexibility of dividend plans make them a good choice for parking funds earmarked for short term financial goals. The dividends serve as a regular income flow for short term needs.
Look for high credit quality
When investing short term, avoid credit risk. Choose schemes that invest predominantly in highest rated AAA and equivalent debt instruments. Scan the portfolio to ensure there is no exposure to low rated or unrated papers. This ensures safety of your capital and timely receipt of maturity proceeds.
Prefer liquid and overnight funds
Liquid and overnight funds provide easy liquidity for idle cash parked for few weeks or months. Liquid funds invest in 91-day T-bills and cash equivalents with no duration risk. Overnight funds just invest in 1-day reverse repos giving higher returns than savings accounts. Use them as short-term parking spaces while waiting to deploy surplus cash.
Analyze recent returns
While past returns do not indicate future performance, analyze trailing returns for consistency. Opt for schemes that have steadily maintained returns in the range of 4-6% over the past 1 year without volatility. Give higher weightage to 6 month and 1 year returns while deciding.
Choose funds with low expense ratio
Short term funds by definition generate modest returns. So opt for schemes with low expense ratios of 0.1-0.2%. This ensures a larger share of your capital is invested and not eroded by costs. Index funds and ETFs in this space have the lowest costs.
Have a balanced allocation
Do not place all your short-term investments in just one fund category or scheme. Allocate across liquid, ultra-short and low duration funds from different fund houses. This balances your portfolio and reduces concentration risk. Stagger your investments across months to average out returns.
With careful selection and monitoring, mutual funds can help you successfully achieve short term objectives while also focussing on long term wealth creation. Choose suitable categories based on timeline, analyze credit quality and minimize costs. Review periodically and redeem on time. Follow this approach for utilizing mutual funds for any short-term needs.