Short-term investments have a very important role in our investment plans. The main role of short-term investments thru savings plans is to preserve your money for a specific goal. For example, your child’s admission for graduation or post-graduation is under process.
Meanwhile, your long-term investment for this very goal has matured and the money is transferred to your bank account.
Now you have a choice, keep the money in your primary bank account or park it somewhere else. If you need to pay the fee in a few days it doesn’t matter. But if you still have a few months before the actual fee payment and other expenses, you would want to park the money somewhere else.
This somewhere else is what we consider a short-term investment. However, you may even end up with longer gaps between your investment’s maturity and goal’s achievement.
For example, you would ideally target the age of 25 for your daughter’s marriage. But, in case she wants to wait till 30, you still have five years to park the accumulated money.
Thus, our definition of short-term investment would not follow the typical definition of short-term investment products in the market. But, the time we often end up with after maturity of investment until the goal’s execution.
Few other assumptions we are making is that you do not need additional tax deduction on your investment. Also, there are very few investment options which allow tax-free maturity within five years of investment. So you should consider all the options regardless of their tax status.
So, for this article, short-term investments will be those which let you invest a large sum of money for up to five years. Here are five such investment options for you:
ULIPs carry a lock-in period of five years. So, the first condition would be to only invest in a ULIP plan if you are certain with the tenure, that you can stay invested for five years in the plan. If you can, you could be in for a tax-treat.
All you need to do is, make sure your life cover in the ULIP plan is at least 10 times of your annual investment. If your premium in a life insurance plan is less than 10% of the sum assured any maturity proceeds are exempt from tax under section 10(10D).
Check the case below to understand how to use ULIP to your advantage when you can only invest for five years:
1. Assuming you have accumulated Rs. 40 lakhs for the marriage goal of your child and you still have about five to six years until marriage
2. The first step is to park this entire money in a liquid fund. Or, if you feel confident enough, divide the money into three parts and invest in the following order:
i. Policy tenure and premium payment tenure of five years
ii. Rs. 8 lakhs as annual premium
iii. Sum assured of Rs. 80 lakhs in the plan
iv. Allocate entire premium into the debt fund
3. For the next two years you will withdraw Rs. 8 lakhs from the liquid fund and invest in the ULIP plan
4. You will need to pay a nominal tax on your withdrawals from liquid funds based on the fund’s earnings
5. Your third and fourth policy premium will come from the debt fund.
6. Since you withdraw this money after three years of investment, your gains from the fund will benefit from indexation. You will still need to pay tax but a lower amount.
7. After five years whatever you have accumulated in the ULIP plan along with any gains on investment will be completely tax exempt.
Bank and Post Office FDs can accept large sums as deposits and offer a fixed rate of interest. Interest would be taxable every year based on your income tax slab. However, your money gets sufficient protection over a short period.
Maturity value you will receive from FDs is not taxable, as you have already paid tax on the interest.
Liquid mutual funds are another great option to park your money for short periods. Especially if you need to save for less than a year. There are no entry and exit charges, investment risk is very low, you may earn more than the bank FD.
If you hold liquid fund investment for less than three years the gains are counted as short-term capital gains and added to your taxable income. But if you hold for more than three years, you get the indexation benefit and a 20% tax rate applies to the gains after indexation.
Indexation refers to the gains being adjusted for inflation. Indexation can reduce your taxable gains by more than 50%. This benefit is not available on bank and post office deposits.
Debt mutual funds would be a better investment if you have more than three years to stay invested. Debt funds may apply an exit load on investment if you withdraw within one year. While tax treatment of debt funds is the same as a liquid mutual fund, you do have a better chance of earning more in debt funds.
So, invest in debt funds if your investment tenure can be more than three years.
The only limitation this plan may face is that if you have an overall life cover of up to 20 times of your annual income. Insurers generally offer maximum life cover up to 20 times of annual income.
You can also contact a financial advisor to help you with this short-term investment plan.
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