Mutual Funds - Short Term or Long Term? Which is Better for you?

02 Jun, 2022

5 min read

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Understand the time frame needed for a mutual fund investment to be classified as a short- or long-term investment and the intricacies that pertain to each

There exist diverse options to choose from when considering mutual funds some of which are designed for the long term while others for the short term. As far as mutual funds short term are concerned, debt funds are worth noting whereas when assessing good mutual funds long-term, equities gain credence. Continue reading to understand what time frame applies to short and long-term funds.

Considering Time Frames of Investments 

As far as tax purposes are concerned, long term investments refer to those that are held for a period that exceeds one year. That being said, when taking the same time frame into account from a mutual fund investment perspective, this time frame wouldn’t necessarily be classified as long term. While it may be classified as long term while the markets are experiencing a bullish trend, it doesn’t apply when sluggish market trends prevail. Take for instance the year 2014 wherein mutual funds provided double-digit returns. During this time, holding a mutual fund investment for a year was sufficient to generate good returns and was long enough whereas, in the year 2018, mutual fund returns weren’t adequate owing to which holding mutual fund investments for a year or two wasn’t long enough. 

Now, if one or two years aren’t necessarily viewed as a sufficiently long enough period to hold mutual funds, certain theories postulate that the longer a mutual fund investment is held, the greater the returns it will provide. That being said, the market works differently and while it may be ideal to hold onto a given mutual fund for a few years, it may not be ideal beyond a certain time frame owing to a number of factors. These include but aren’t limited to, the strategy employed by the fund changing, the fund no longer aligning with your investment goals or, it not even existing 15 years later. Therefore, the main takeaway here is to continuously monitor your portfolio to minimize your exposure to risks.

Deciding When to Invest and When to Exit a Mutual Fund Holding

The decision to define a certain time frame as long term is relative primarily as different investors have different profiles and wish to fulfill different goals. Instead, two areas that are worth paying attention to focus on when investments ought to be made and when they should be exited.

As far as ‘when to invest’ is considered, systematic investment plans (or SIPs) gain credence. By investing in mutual funds using SIPs you can average the cost of your investment and can accrue greater returns via the power of compounding. 

Exiting an investment on the other hand can be tricky owing to which investors are encouraged to invest in accordance with their goals. This helps you set a target amount and the tenure over which you hope to achieve it. This isn’t to say that the market can undergo major changes over the course of time you allocated to your goal which in turn can impact your portfolio returns. Owing to this very reason, it is worth defining what a long-term investment would be. Long term investments here amount to 7 years.

Areas to Consider When Investing Over the Long Term

Although long term investments are ideal, it is worth taking into account the following considerations.

Conduct Adequate Research – This can help you find a fund that best aligns with your financial goal. Take into account a fund’s performance in the past, its objectives, investment strategies, the fund manager’s credentials and track record prior to shortlisting it. 

Diversify Your Holdings – One of the most prudent measures you can take to balance your risk is by diversifying your investments. Given that mutual funds invest in an array of securities they help in this regard. By going for a fund that invests across an array of sectors it is possible for you to diversify your holdings.

Make Use of a Strategy – If you wish to hold on to an investment over the long term it is important to map out, clearly define and follow through with your strategy. By saving with regularity, you can create a rich corpus for yourself.

Defining Short term Investments

In contrast to long-term mutual fund investments that last a period of 7 years, short-term investments range from a period of a few days to up to 3 years. In this regard, liquid funds and ultra-short-term debt funds are worth noting.

Short term funds are capable of offering greater returns in contrast to traditional savings accounts but are subject to market risks owing to which these returns aren’t guaranteed. That being said, short term mutual funds are far less volatile to interest rate slashes. 

Comparing Short- and Long-Term Mutual Funds 

Examine the table provided below in order to understand the ways in which short- and long-term mutual funds differ.  

Area of Consideration

Short-Term Mutual Fund Investments

Long-Term Mutual Fund Investments

Time Frame

Range from a few days to up to three years

Five to seven years and in some scenarios an additional amount of time 

Sensitivity to Interest Rate Slashes

Less sensitive

Highly sensitive

Returns

Greater returns in comparison to traditional savings schemes 

Great returns owing to the power of compounding

Risk

Low risk in comparison to long-term investments

High risk in comparison to short-term investments

Goals

Ideal for short-term goals that include buying a vehicle or going for a vacation

Ideal for long-term goals that include saving for your retirement or your child’s higher education

Wrapping Up

Ultimately, determining whether a short- or long-term mutual fund suits you best, you must take a look at your own profile, the threshold for risk, investment goals and the time frame you are willing to devote to your mutual fund investment. 

Disclaimer: This blog is exclusively for educational purposes and does not provide any advice/tips on investment or recommend buying and selling any stock.

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