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What are Short-Term Investments: A Complete Guide

Updated on: Apr 25th, 2023

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9 min read

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Whether you are a business owner or an individual, short-term investments can help you earn decent returns over a short period of time while keeping a low-risk profile. Not just this, but short-term investments are readily available and can be converted into cash at any time. They also provide a stable source of income for MSMEs and help them meet their working capital needs, thus facilitating their growth. This article talks in detail about the types of short-term investments available and their benefits for MSMEs. 

What are Short-term Investments? 

Short-term investments are financial instruments that are meant to be held for a short duration, typically less than a year. In other words, short-term investments are financial instruments that are highly liquid and can be easily converted to cash. They are generally low-risk and provide lower returns as compared to long-term investments. These instruments are a good way to generate wealth in the short term. Both individuals and companies invest in short-term financial instruments as it helps them meet their short-term obligations. 

Importance of Short-term Investments for MSMEs

Working capital shortage is one of the most common problems faced by MSMEs. Short-term investments are a great way to generate income in the short run to meet the increased working capital needs. These investments are highly liquid in nature and can be sold or withdrawn at any time. This makes it easier for MSMEs to fund their working capital needs and create wealth at the same time. Moreover, these investments are very low risk and therefore help preserve capital. 

Types of Short-Term Investments

Short-term investments play a crucial role in the growth of MSMEs by helping them manage their liquidity and limit their risk exposure. If you are an MSME owner looking for the best short-term investment instruments, here are the best short-term investment options to consider -

1. Bank Fixed Deposits (FDs): Fixed deposits are a type of investment where you deposit a certain amount of money with a bank or financial institution for a fixed period of time, usually ranging from 7 days to 10 years. Apart from being popular, FDs are also one of the safest investment options. The interest rate on FDs does not frequently change, thus providing a stable income. You can withdraw an FD before the maturity period, subject to a penalty. Moreover, you can also invest in tax-saving FDs that offer deductions up to INR 1.5 lakh under Section 80C of the Income Tax Act, 1961. 

2. Savings Accounts: Savings accounts are types of deposit accounts offered by banks where you can keep your money safe and earn interest on it. The interest rates on savings accounts are generally lower than FDs but provide easy access to your money. These accounts are highly liquid and allow you to withdraw money anytime you want. Moreover, you can deposit an unlimited amount in a savings account and use it as per your needs. 

3. Debt Mutual Funds: Debt mutual funds are the types of funds that typically invest in debt-related instruments like government bonds, corporate bonds, and money market instruments. These types of instruments offer a fixed income over their tenure and are free from stock market fluctuations. Such instruments are a great option for risk-averse investors and help MSMEs manage their total risk by maintaining a healthy ratio of debt and equity investments. Here are a few examples of debt funds -

  • Liquid funds: Money market instruments having a maturity of up to 91 days.
  • Short-duration funds: With a maturity duration of 6-12 months. 
  • Ultra short-duration funds: With a maturity duration of 3-6 months. 
  • Money market funds: With a maximum maturity of one year.
  • Corporate bond funds: Low-risk funds with a minimum of 80% of their total assets in good corporate bonds.
  • Banking and PSU funds: With a minimum of 80% of its total assets invested in debt securities and PSUs.
  • Floater funds: Funds which invest a minimum of 65% in floating rate instruments, thereby bearing a low interest-rate risk.
  • Overnight funds: Securities with a maturity period of one day.

4. Treasury Bills (T-Bills): T-bills are short-term debt instruments issued by the Government of India with a maturity period ranging from 91 days to 364 days. They are regarded to be one of the safest short-term investments available in India. They offer high liquidity, safety, and good returns. These instruments are issued at a discount and redeemed at a nominal value. T-bills are also known as zero coupon bonds, which means they do not earn interest. Instead, the T-bill owner earns from the difference between the issue rate and the nominal value. 

5. Commercial Papers (CPs): Commercial papers are unsecured debt instruments issued by corporates with a maturity period of up to 1 year. They offer relatively higher returns than T-bills but are considered to be slightly riskier. These investments cannot be withdrawn. 

6. Certificate of Deposit (CDs): A certificate of deposit is a time deposit issued by banks and financial institutions with a maturity period ranging from 7 days to 10 years. They offer higher returns than savings accounts but are less liquid. Although CDs are similar to FDs, the minimum investment amount in CDs is Rs.1 lakh. Therefore they are preferred by organisations and institutions. 

7. Equity Linked Savings Scheme (ELSS): ELSS is a type of mutual fund that invests in equity and provides tax benefits under Section 80C of the Income Tax Act. They have a lock-in period of 3 years and are considered to be slightly riskier than other short-term investments.

8. ETFs: Exchange-traded funds are marketable securities that track a particular index, bond, commodity or a basket of assets. These investments do not have any lock-in period and can be converted into cash easily. ETFs are highly liquid as they are traded on a stock exchange. 

9. Invoice Discounting: Invoice discounting is a non-collateral supply chain credit, where suppliers are paid early by corporate customers against a discount. Corporate investors can help businesses by providing them with instant cash against their invoices at a certain discount and earning returns on their investment in the short term.

10. Securities Market: Another popular short-term investment option is trading or investing in the stock market. Depending on one’s investment goals, risk capacity, and investment tenure, there are chances of earning high returns. However, the stock market is risky and unpredictable and should be an investment option for those with a high-risk appetite. 

Advantages of Short-Term Investments for MSMEs

Short-term investments help small enterprises meet their working capital needs and balance their risk exposure. Here are some benefits of short-term investments for MSMEs (Micro, small and medium enterprises):

  1. Liquidity Management: MSMEs often face cash flow challenges, and short-term investments can help them manage their liquidity needs. By investing in short-term instruments such as money market funds or treasury bills, MSMEs can earn a return on their excess cash and also keep it readily available for operational needs. 
  2. Risk Management: Short-term investments are typically less risky than long-term investments, making them an ideal option for MSMEs that may not have the financial cushion to absorb large losses. By investing in short-term securities, MSMEs can reduce their exposure to market volatility and protect their capital.
  3. Capital Preservation: MSMEs may need to keep their funds available for upcoming expenses, such as paying suppliers or investing in new equipment. Short-term investments can help preserve their capital while earning a return, allowing them to meet their financial obligations without sacrificing their cash reserves.
  4. Flexibility: Short-term investments offer high flexibility to investors and allow them to invest in different instruments within a short time period. Since the investment amount is not tied up in a single instrument for a long period of time, it provides more flexibility. 

Overall, short-term investments can play a crucial role in financial management for MSMEs by providing liquidity, managing risk, preserving capital, and offering easy access to funds. They can also be a great source of extra income for risk-averse individual investors who cannot take high risks but still want decent returns. 

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