How to Invest in Mutual Funds : Short-Term vs Long-Term Goals

When it comes to investing in mutual funds, time matters. Some people need funds in a couple of years. Others are planning for an event that is decades away. This time frame can have a significant influence on the type of mutual fund you choose and the way you invest.

Understanding short-term and long-term goals

Short-term goals may fall within one to three years. These could be things like building a buffer for emergencies, paying for a planned trip, or funding a home renovation. Long-term goals may stretch over five years or more — retirement savings, your child’s education, or building wealth.

The difference is not just in years, but also in how much risk you can take. For shorter horizons, relative stability of capital may be more important. For longer horizons, the potential to earn returns that can outpace inflation may be a priority. Such investments may entail higher risk, but the extended horizon gives you more time to recover from market fluctuations.

Mutual fund options for short-term goals

For short-term goals, investors typically seek categories that carry relatively lower volatility. Liquid funds, ultra short duration funds, or short duration funds are some options. These funds typically invest in fixed-income instruments with shorter maturities. While they may not offer the higher potential returns of equities, they can provide liquidity and reduce exposure to sudden market swings.

Mutual fund options for long-term goals

Long-term investing opens up more options. Equity-oriented funds, for instance, may be suitable for investors with a higher risk tolerance, as they carry the potential for higher returns over extended periods. Categories such as large cap fund, flexi cap fund, or small cap fund may be part of this mix. A small cap fund invests in companies with lower market capitalisation, which can be more volatile in the short term but may offer greater growth potential over the long run.

Choosing the suitable investment mode

Your investment mode can also depend on your time frame. For short-term needs, a lumpsum investment may be suitable if you already have the money and know exactly when you will need it. Moreover, your entire capital gets put to work at once when you invest in lumpsum.

For long-term goals, a Systematic Investment Plan (SIP) may be suitable. By investing smaller amounts regularly, you spread your purchases across different market conditions. This can average out the cost of your investments over time and can help you navigate volatility.

The role of compounding over time

Compounding works differently for short-term and long-term investments. Compounding happens when the returns on an investment are reinvested and go on to earn further returns. Over time, this can potentially have a multiplier effect on your wealth. 

However, in the short term, the impact of compounding may be limited because the money is invested for fewer cycles. For long-term investments, however, compounding can significantly influence the final value. 

Managing risk and reviewing investments

Risk management should be part of both short- and long-term investing. For short-term goals, it can be risky to chase higher potential returns by taking on more volatile investments. For long-term goals, avoiding all risk may mean missing out on the potential for inflation-beating returns or wealth-building. 

Apart from suitable fund selection, one way to manage risk is to diversify your investments across asset classes. For long term investments, allocating a portion of your portfolio to debt funds or hybrid funds may help add relative stability to the portfolio. 

Short-term investments may need closer monitoring, given the limited time frame. You can track fund performance and compare metrics easily through a reliable company financials website, which helps investors make informed decisions based on data trends.

As you move closer to your goal, you may gradually shift from higher-risk funds to relatively lower volatility options so as to reduce the impact of volatility on your corpus. 

Bringing it all together

To sum up, the way you invest in mutual funds should match your time horizon, your tolerance for risk, and the purpose behind your investment. Short-term and long-term goals call for different approaches, but the underlying principles remain the same — choose thoughtfully, invest consistently, and review periodically. Every investment carries some level of uncertainty, but aligning your strategy with your time frame can help you navigate the journey with greater clarity.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.

The content herein has been prepared on the basis of publicly available information believed to be reliable. However, Bajaj Finserv Asset Management Ltd. does not guarantee the accuracy of such information, assure its completeness or warrant such information will not be changed. The tax information (if any) in this article is based on current laws and is subject to change. Please consult a tax professional or refer to the latest regulations for up-to-date information.