Where to invest for the next three-four years?

Hello, I have some money that I will need in three-four years. The goal is a bit flexible. Would it be a good idea to invest in long term bond funds (e.g., gilt funds) to take advantage of the current high interest and possible benefit of interest drop? Is there a better option for this time frame? - Ankit Mundra

Interest rates and credit cycles are rather unpredictable as they can be subject to event driven shocks as well as macro economic factors. Take the case of interest rate cuts in March-May 2020 to stabilise the financial markets in the backdrop of COVID-19 pandemic (event driven) as well as the recent rate hikes to keep inflation in check (macro factor).

No one can predict the interest rate cycles with absolute certainty and positioning your portfolio anticipating such events can be a risky bet as the downside is that you are not able to meet your financial goals. So, it is better to invest focusing on your investment horizon and priority of the goals rather than macro events.

So where to invest for three-four years?
Short-duration debt funds.

For an investment horizon of three-four years, if the priority is to earn returns better than bank fixed deposits while keeping your capital safe, then short-duration funds are the way to go. The duration of these funds match your investment horizon and thus they mitigate the price risk to a great extent, i.e., the price fluctuation due to changing interest rates.

Why choose short-duration debt funds over long-term bond funds?
The objective of investing in fixed income securities is to generate stable returns, avoid the price fluctuations and volatility that equities bring and to keep your capital relatively safe. While long term bond funds, such as gilt funds, might look attractive, they are highly volatile and provide returns similar to that of short-duration bond funds in the long run. You can read more about them here.

Moreover, when choosing debt funds, it is advisable to match the funds' duration and maturity with that of your investment horizon. This is because the longer the duration and maturity of the portfolio, the more sensitive it becomes to price fluctuations.

Equity savings funds are also an option
Since your investment horizon and goal is slightly flexible, you may also look at equity savings funds, provided you are willing to assume the risk that comes with allocation to equities. These funds invest in equities, debt and arbitrage opportunities. They offer slightly higher returns than gilt funds. The asset allocation that they follow provides the benefits of equities without the volatility of a pure equity portfolio due to allocation to debt and cash as well.

Suggested read: Should you invest in a debt fund with a three year horizon?

This article was originally published on January 02, 2023.