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When Time Matters

I have invested Rs one lakh in a short-term fund. For how long should remain invested in this fund. I also intend to invest in an income fund. For what time period I should invest in this fund.

I am a housewife and also a senior citizen. I have invested Rs one lakh in a short-term fund. How long should I hold on to this investment? That apart, I also intend to invest in an income fund. What time limit would you advise for this investment?
Andal Sharma, via e-mail

Following a two-pronged approach to debt investing is a sensible decision. While a short-term fund will take care of your immediate liquidity requirements, an income fund will give you stable returns over the long-term. The decision to stay invested should, therefore, be guided by your financial requirements and investment goals.

Before we move further, one needs to understand a few things. First and foremost, it is important that one realises the suitability of a particular fund before making any investment. Short-term funds serve the purpose well if one is looking at parking one's investible surplus for a period of three to six months. Investors stay committed to them for three reasons: liquidity, capital preservation and income. Since these funds invest only in shorter-maturity corporate bonds, government securities and money market instruments, they are less susceptible to interest rate changes and are less volatile. Therefore, they offer lower returns than an income fund, but higher returns than a cash fund.

Income funds too invest in corporate bonds and gilts, but in longer-maturity papers, which are more susceptible to interest rate movements. Since these longer-tenure papers—particularly gilts—are volatile in nature, income funds are more volatile than short-term funds. One should thus have a minimum investment horizon of over one-year for an income fund. This holding period helps in ironing out any volatility which may occur. Higher volatility means higher returns as well. In the past one year, as on December 24, 2002, income funds have posted on an average 13.9 per cent return, while their short-term counterparts have given nine per cent.

Now that you have some idea about these funds, the first step should be to ascertain what your financial goals are and the time frame within which you wish to realise them. Different time horizons require different investment strategies. If you have an investment horizon of over one-year, then you should pick an income fund. As for your investment in a short-term fund, if you need money in the immediate future, then we suggest that you stay put. Otherwise, transfer the money to a higher-yielding option, such as an income fund.

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