Short term vs long term mutual funds: What is the difference?

When it comes to investing, the time horizon plays a crucial role. Whether you are investing for a couple of months or for several years can influence the potential returns you generate and the risks you take on. In this regard, short term funds often focus on stability and liquidity, whereas long term mutual funds target growth over extended periods.

Deciding between the two boils down to your unique financial objectives, risk tolerance, and investment horizon. By understanding the nuances of short term vs long term mutual funds, you can make well-informed decisions that align with your life goals.

Table of contents

• Difference between long-term mutual funds and short-term mutual funds
• How long should you remain invested in mutual funds?
• Pros and cons of long-term and short-term mutual funds
• Who might consider long-term investment strategies?
• Who might consider short-term investment strategies?

Difference between long-term mutual funds and short-term mutual funds

To begin with, let us look at the primary differences between short term vs long term mutual funds –

Factor	Short term mutual funds	Long term mutual funds
Time horizon	Up to 3 years. Examples: ultra-short term funds, short term debt funds, short term funds	Usually more than 3 years up to 5, 10, or even 20+ years.
		Usually more than 3 years up to 5, 10, or even 20+ years.
Objective	Preserving capital, earning moderate returns, maintaining liquidity.	Capital appreciation, wealth creation, higher but more volatile returns.
Risk profile	Generally lower. Bond funds, money market instruments.	Generally higher. Often includes equity funds.
Volatility	Lower volatility since investments are in debt funds or money market instruments in general.	Higher volatility, especially in equity-oriented funds, due to market fluctuations.
Returns	Tends to be moderate, aligned with debt market yields in general.	Potentially higher returns over the long run, especially in equity funds.
Investment strategy examples	Short term SIP, short term SIP investment in low-duration or ultra-short term schemes.	Long term mutual funds to invest in equity-based or balanced schemes.

How long should you remain invested in mutual funds?

The duration for which you should ideally remain invested depends on:

1. Financial goals

• If you need funds in the near future (e.g., planning a wedding, paying for an upcoming expense), short term funds could be suitable.
• If you’re building a retirement corpus or saving for your child’s higher education, long term mutual funds may offer a better long-term avenue for growth.

2. Risk appetite

• People who can handle volatility and desire higher potential returns may lean towards equities, which generally require a long term commitment.
• Investors preferring capital preservation and lower market risk typically choose short term debt funds or ultra-short term funds.

3. Market conditions

• Certain economic climates may favour long term mutual funds if equity valuations are suitable for long-term investing.
• Conversely, if interest rates are favourable or you want a modest-but-stable return potential without locking in money for long, short-term instruments might be appealing.
  Remember, “time in the market” often matters more than “timing the market.” Consistent investing, whether short- or long-term, can make a significant difference in reaching your financial goals.

Pros and cons of long-term and short-term mutual funds

Pros of short-term mutual funds

• Liquidity: If you need quick access to your money, short term funds are more accessible.
• Lower volatility: Fluctuations in NAV (Net Asset Value) are less dramatic since most short-term schemes invest in relatively more stable, lower-duration instruments.
• Suitable for short-term goals: If you’re saving for a vacation or an emergency fund, these funds fit the bill.

Cons of short-term mutual funds

• Returns potential: Even though they are less volatile, short term funds often offer modest returns, which might not outpace inflation if held for too long.
• Limited growth: They do not harness the power of compounding to the same extent that equities can over years.
• Interest rate sensitivity: Short term debt funds can face fluctuations if interest rates change.

Pros of long-term mutual funds

• High growth potential: Over longer horizons, equity-oriented funds can significantly appreciate, thanks to compounding and economic growth.
• Wealth creation: Suitable for building a substantial corpus over time (e.g., retirement, children’s education).
• Tax efficiency: Holding equity funds over a year reduces your tax liability on gains.

Cons of long-term mutual funds

• Higher volatility: Short-term market movements can lead to temporary portfolio downturns, testing your patience.
• Lock-in or mindset constraint: Although mutual funds don’t always impose a lock-in period (barring certain schemes like ELSS), a long-term mindset is crucial to ride out dips.
• Requires discipline: You must continue investing or remain invested for years, which can be challenging during market downturns or personal cash flow issues.

Who might consider long-term investment strategies?

• Individuals with high risk tolerance: If you can handle market volatility, long term mutual funds to invest (especially equity-focused) can yield higher returns over the years.
• People with extended financial goals: When you have goals like retirement planning, children’s higher education, or purchasing a home in 10-15 years, long-term funds can help achieve these milestones effectively.
• Wealth accumulators: If you’re young or in the prime of your earning years, consider building a corpus through long-term investments. Equity markets have historically outperformed fixed-income instruments over long durations.
• Those looking for tax benefits: Long-term capital gains, especially in equity-oriented funds, often attract favourable LTCG tax rates.

Who might consider short-term investment strategies?

• Investors with immediate goals: If you need funds in the next 1-3 years for emergencies, marriage expenses, or home renovations, consider short term mutual funds.
• Low risk appetite: Market fluctuations might be stressful. Short term debt funds or ultra-short term funds can provide relative stability and peace of mind.
• Bridging liquidity needs: If you’re unsure about your near-future financial commitments, short-term schemes allow you to preserve capital while earning modest returns.
• Alternative to Saving Accounts: Instead of stashing money in bank savings accounts with low interest, you can consider a short term SIP investment to potentially earn a relatively better return potential without committing for years.

Conclusion

Choosing between short term vs long term mutual funds boils down to your financial goals, the timeline for achieving them, liquidity needs, and your comfort with market fluctuations. Short term funds can be suitable for meeting imminent needs or for investors with low risk tolerance. In contrast, long term mutual funds—particularly equity-focused—are designed for wealth creation and can deliver a substantial return potential over an extended timeframe.

However, it’s crucial to remember that all investors are unique and you might hold both short-term and long-term investments simultaneously. Astute investors often diversify across different kinds of mutual funds, balancing out immediate cash flow requirements with the pursuit of long-term growth. By aligning your investment strategy with your personal objectives, you can find peace of mind and steady progress toward your financial aspirations.

FAQs:

Which is better, short term or long term investment?

Neither is universally “better”—it depends on your personal goals and risk profile. Short term mutual funds offer lower risk and quick liquidity, whereas long term mutual funds may yield higher returns given enough time albeit with a higher associated risk.

Can I invest in both short-term and long-term funds?

Absolutely. Many investors maintain a balanced portfolio that includes short term funds for liquidity and long term mutual funds for wealth accumulation.

What if my financial goals change over time?

Your investment plan isn’t set in stone. You can rebalance your portfolio, shifting from short-term to long-term schemes (or vice versa) to match your evolving objectives.

How much should I invest in each type of fund?

The allocation varies based on factors like risk tolerance, time horizon, and financial milestones.

Are there any tax benefits to consider?

Yes. Long-term capital gains on equity funds (held for more than one year) are taxed at 12.5% beyond the Rs. 1.25-lakh annual exemption. Short-term equity gains attract a 20% tax, if sold within a year. Debt fund gains are taxed as per the investor’s applicable tax slab regardless of the holding period. Always verify current regulations, as tax laws can change.

Which is more expensive, short term or long term investment?

Cost here may refer to taxes, fees, or opportunity costs. Short term funds might involve frequent transactions or exit loads, while long term mutual funds may impose minimal exit loads if you stay invested longer. Compare expense ratios to know which is cost-effective for you.

What are the disadvantages of short term investing?

Short-term investing might yield lower returns and can also subject you to transaction costs and taxes if you frequently buy and sell. Additionally, you may miss out on the power of compounding that benefits long-term investments.

Which is riskier, short or long-term?

Generally, long term mutual funds (especially equity-focused) are more volatile in the short run, but they could yield higher returns if you stay invested for years. Short term funds are less volatile but often provide a lower return potential, which may not keep pace with inflation over long periods.

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 an 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.