Economic Times, Friday, November 10, 2006
There has been a shift in the nature of debt investments for several individuals. Short-term deposits, as well as other short-term instruments, are suddenly a big hit with certain sections of the investing population. However, investors need to understand how these can be utilised effectively and can benefit individuals in the overall planning process.
Nature of instruments
Short-term instruments are available across a range of investment options. Two of the most popular ones are bank fixed deposits (FDs) and short-term mutual funds (MFs). Short-term FDs usually range from a couple of weeks to a year. Instead of months, the banks notify these deposits in terms of the number of days. These deposits are meant for individuals who want to park their money for a short period of time. Mutual funds, on the other hand, pool together the resources of a large number of people and then invest these in the specified instruments, as laid out in the offer document of the scheme. Short-term funds invest in short-term instruments that mature within a year, so that the risk-return equation matches the investor’s requirement. These are useful for individuals who want to put away their money for a short period of time and also want it back by a specified date. The options here include liquid funds, short-term funds and fixed maturity plans.
Risk-return measures
Investors have to carefully analyse the risk-return equation for both these types of investments. The return on these instruments is traditionally lower than that earned on long-term instruments, but this has to be seen in the context of the risk element. The risk is reduced to a large extent because safety is the primary feature of this investment, which is often at the cost of some extra return that could have been earned. Hence, investors should not expect a very high rate of return — 5-6% has been the norm in the past couple of years in terms of earnings on the investment.
Change in rates
The returns generated by bank FDs have witnessed a change recently. Several banks have pushed up short-term rates and hence, in several cases, the rates on short-term instruments are similar or just marginally less than that earned on long-term deposits. Rates for short-term deposits may even rise to 8% on an annual basis. Similarly, short-term rates have risen on several debt instruments, especially fixed maturity plans. Hence, investors can make the best use of the situation.
Check for a final calculation
While the rates are attractive and several investors are opting for these instruments, there are certain factors that individuals need to consider before taking the final decision. The first is whether individuals want to take the advantage of higher rates in the short term or park their money in long-term instruments. The danger in using short-term instruments is that when the initial investment matures, the tide could have turned and the rate of earning may have reduced. Hence, the person may be worse off than what he would have been, had he gone in for the long-term investment. The next point to consider is whether the individual needs money at a specific point of time in the short term. If this is the case, then he should go in for short-term instruments. The final point to be considered is whether a good bargain is available, such as high rates on short-term instruments on a net or after-tax basis. The gross rate may be high, but if a large amount goes towards paying taxes, the net earnings may not justify the effort taken to invest in these instruments.
There has been a shift in the nature of debt investments for several individuals. Short-term deposits, as well as other short-term instruments, are suddenly a big hit with certain sections of the investing population. However, investors need to understand how these can be utilised effectively and can benefit individuals in the overall planning process.
Nature of instruments
Short-term instruments are available across a range of investment options. Two of the most popular ones are bank fixed deposits (FDs) and short-term mutual funds (MFs). Short-term FDs usually range from a couple of weeks to a year. Instead of months, the banks notify these deposits in terms of the number of days. These deposits are meant for individuals who want to park their money for a short period of time. Mutual funds, on the other hand, pool together the resources of a large number of people and then invest these in the specified instruments, as laid out in the offer document of the scheme. Short-term funds invest in short-term instruments that mature within a year, so that the risk-return equation matches the investor’s requirement. These are useful for individuals who want to put away their money for a short period of time and also want it back by a specified date. The options here include liquid funds, short-term funds and fixed maturity plans.
Risk-return measures
Investors have to carefully analyse the risk-return equation for both these types of investments. The return on these instruments is traditionally lower than that earned on long-term instruments, but this has to be seen in the context of the risk element. The risk is reduced to a large extent because safety is the primary feature of this investment, which is often at the cost of some extra return that could have been earned. Hence, investors should not expect a very high rate of return — 5-6% has been the norm in the past couple of years in terms of earnings on the investment.
Change in rates
The returns generated by bank FDs have witnessed a change recently. Several banks have pushed up short-term rates and hence, in several cases, the rates on short-term instruments are similar or just marginally less than that earned on long-term deposits. Rates for short-term deposits may even rise to 8% on an annual basis. Similarly, short-term rates have risen on several debt instruments, especially fixed maturity plans. Hence, investors can make the best use of the situation.
Check for a final calculation
While the rates are attractive and several investors are opting for these instruments, there are certain factors that individuals need to consider before taking the final decision. The first is whether individuals want to take the advantage of higher rates in the short term or park their money in long-term instruments. The danger in using short-term instruments is that when the initial investment matures, the tide could have turned and the rate of earning may have reduced. Hence, the person may be worse off than what he would have been, had he gone in for the long-term investment. The next point to consider is whether the individual needs money at a specific point of time in the short term. If this is the case, then he should go in for short-term instruments. The final point to be considered is whether a good bargain is available, such as high rates on short-term instruments on a net or after-tax basis. The gross rate may be high, but if a large amount goes towards paying taxes, the net earnings may not justify the effort taken to invest in these instruments.
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