If the money earns a return that is lower than the rise in prices, its value can be reduced over time, so short-term investments should not only be looked at based on the return they generate.
Keeping money aside for a short period may seem simple, but there is another factor investors need to consider: inflation. If the money earns a return that is lower than the rise in prices, its value can be reduced over time.
This is why short-term investments should not only be looked at based on the return they generate. Investors also need to see whether the return is enough to stay ahead of inflation while keeping the money relatively stable and accessible.
What happens to money during inflation?
Inflation means the prices of goods and services increase over time. As prices rise, the same amount of money can buy fewer things than it could earlier.
For example, if you keep Rs 1 lakh aside and it earns very little over a few years, the amount may remain close to Rs 1 lakh. But if prices rise during the same period, that Rs 1 lakh will not have the same purchasing power.
This is why simply keeping short-term money idle may not always be the best option.
Where can short-term money be invested?
The right option depends on when the money is needed and how much risk an investor is comfortable taking.
For money that may be required within a relatively short period, investors may look at options such as bank deposits, liquid funds and short-duration debt funds.
Short-duration debt funds invest mainly in fixed-income securities and have a relatively shorter portfolio duration compared with longer-duration debt funds. They can therefore be considered by investors who want to keep money invested for a limited period without taking the same level of risk as equity investments.
How can you check whether your money is keeping up?
One simple way is to compare the expected return from an investment with the inflation rate.
For example, if an investment earns 6% and inflation is 5%, the return is only slightly ahead of inflation before considering taxes and other costs.
This is where a SIP calculator with inflation can be useful. An investor can use a calculator to estimate how regular investments may grow over time and compare the projected value with the effect of inflation.
The calculation does not guarantee what the fund will actually earn. It is mainly useful for understanding how the investment amount and inflation can affect the value of money over time.
Why consider ultra short duration funds?
Ultra short duration funds invest in debt and money market instruments with a very short portfolio duration. They are generally meant for investors who want to park money for a short period while earning a return from fixed-income investments.
However, they are still mutual funds and are not the same as a bank fixed deposit. Returns are not fixed or guaranteed, and the value of the investment can change.
This is why investors should look at the fund's portfolio, risk level, expenses and investment horizon before putting their short-term money into it.
What should investors check?
Before choosing a short-term investment, it can help to look at:
Investment period: When will the money be needed?
Expected return: What return can the investment reasonably generate?
Inflation: Is the return likely to remain ahead of rising prices?
Risk: How much fluctuation can the investor accept?
Liquidity: How easily can the money be withdrawn when needed?
Conclusion
Short-term money also needs to be looked at from the point of view of inflation. The aim is not simply to earn a return, but to make sure the money does not lose too much purchasing power while it is sitting invested.
Comparing the expected return with inflation and using a calculator to understand the possible outcome can help investors make a more informed decision.
(The views and opinions expressed in this guest article are solely those of the author and do not necessarily reflect the views of Eastern Mirror)