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Whether you’re looking to work towards a specific savings goal or you simply want to start growing your money — there is now a range of short term investment options that will allow you to do this with ease. Unlike long term investment vehicles such as stocks and shares, short term investment products will typically see you hold on to the investment for less than five years.
Moreover, you’ll likely find that short term investments are often less liquid, meaning that you won’t be able to cash the investment out until its respective term has been reached. Nevertheless, if you are thinking about making some short term investments, but not too sure how things quite work — be sure to read our in-depth guide.
We cover everything that you need to know, such as what short term investments actually are, whether or not they fit into your wider investment goals, and how they compare with longer-term investments.
To help you along the way, we will also discuss some of the best short term investment options available in the market today.
What are Short Term Investments?
A short term investment is typically classed as an investment that is held for fewer than five years. In most cases, individuals will have a clear investment goal in mind. This could be anything from saving for a down payment on a house or working towards a savings goal. The overarching concept of short term investing is that in most cases, you will know exactly how much you are going to make.
For example, let’s say that you invested $10,000 into a 3-year fixed-term CD Account that pays 5%. As soon as you make the investment, you will know exactly how much interest you are going to make, and for how long. In this example, your $10,000 CD Account investment would return $12,762 – subsequently growing your money by $2,762.
Although the returns on short term investments are typically lower than their long term counterparts, it is important to remember than they are typically viewed as low-risk. Furthermore, it’s better to invest in a short term investment vehicle than simply leaving the funds in a conventional savings account. In doing so, you can at the very least avoid the undesired effects of inflation.
When Would This Be a Good Investment Strategy?
People typically opt for a short term investment strategy when they have a clear goal in mind. Shrewd investors know that by leaving their money in a bank account, not only will they lose the opportunity to grow their money, but they’ll essentially lose money once inflation is taken into account.
As such, if you’re looking to inject capital into the financial markets, but you don’t want to lock your money away for too long, then a short term investment is a sound solution.
Short term investing is also a good strategy to employ if you have a low tolerance towards risk. While it is true that certain short term investments such as peer to peer lending, do come with a higher level of risk, others such as CD Accounts or Short Term Bonds come with little, if any risk at all. Thus, if you do have a clear investment goal in mind, some short term investments allow you to achieve this without taking on much risk.
On the other hand, short term investing can also be a good strategy in the event of an impending bear stock market. Don’t forget, a bear market means that there are more sellers than buyers, meaning that stock prices typically go down for an extended period of time.
By investing in low-risk short term investment products, you stand the chance of avoiding stock market turbulence and instead make slow and steady gains. Once you feel that it is a good time to re-enter the stock market arena, you then have the opportunity to purchase your desired shares at a discounted price.
Long Term vs Short Term Investments
Apart from the length of time that the investment is held for, there are a number of key differences between a long term and short term investment. These are:
By investing in a short term investment vehicle, you will all-but surely make less than what a long-term investment product can potentially yield.
First and foremost, you need to remember that by holding onto your investment for a shorter period of time, you will not benefit from the full effects of compound interest. This is where you effectively earn ‘interest on your interest’. The longer you are able to do this, the faster your money will grow over time.
As short term investments are often less risky than long term investments, this also comes with a lower rate of return. Don’t forget, the ‘Risk vs Reward’ model dictates that the more risk we take, the higher the returns we should receive.
As we briefly noted earlier, those investing in short term financial products will typically have different goals to those investing in long term investment vehicles. For example, those investing in long term products such as stocks and shares will usually do so because they are looking to grow their money in the long-run.
By this, we mean that they might be saving for their retirement, or to grow enough money to put their children through college. Either way, the long term investor will potentially be looking at holding their portfolio for many decades.
On the contrary, short term investing is typically done to meet a specific goal that can be realized in the short-run. For example, let’s say that you have a lump sum of cash, wish you want to safeguard until you are ready to buy your first home.
Sure, you could leave the cash in the bank and barely make 0.1% in interest, or you can instead place the money into a short term investment product. In doing so, not only will you be able to grow your money faster, but you also have a clear assessment of when you are going to get your investment back.
Although the specific risk levels will, of course, depend on the asset class that you decide to invest in, short term investments typically come with less risk than long term investments. One of the main reasons for this is that long term investments are usually a lot more volatile.
For example, if you were to invest in the stock markets, the general consensus is that you will always experience ups and downs. However, by holding on to your stocks over many, many years, you should be able to ride these volatile waves outs.
On the other hand, short term investments often come with a fixed rate of interest, so all being well, there should be no surprises for the investor at the end of the term. This isn’t to say that all short term investments are low-risk. As we noted earlier, the likes of peer to peer investing can be super high-risk, as you are lending money to people that stand a very real chance of defaulting on the loan.
On the contrary, if investing in a CD Account, Online High-Interest Savings Account or a Money Market Account — these are usually protected by the Federal Deposit Insurance Corporation (FDIC). As such, if the underlying financial institution went bust, your money would be protected up to the first $250,000. A safeguard such as the FDIC rarely exists in the long term investment arena.
Best Short Term Investments
So now that you know what short term investments are, and how they differ to a long term investment, we are now going to discuss some of the most common investment vehicles utilized by short term investors.
Online High-Interest Savings Accounts
If you were to place your money into a traditional bank account such as those offered by the likes of Chase or Wells Fargo, you’d be lucky to earn more than 0.1% in annual interest. However, online-only banks are significantly more competitive, not least because their overheads are much lower. This allows them to offer a higher rate of interest to savers, while still keeping the investment low-risk.
In fact, by sticking with an online bank that is protected by the FDIC, you can invest up to $250,000 without taking any risk whatsoever. In terms of how much you are likely to make on your money, this can be as high as 2% APY. As such, this is much higher than what the traditional banks will pay!
At the time of writing, the likes of the Citizens Access Online Savings Account and Discover Online Savings Account come out on top, with an APY of 2% and 1.90%, respectively. Take note, while a lot of online high-interest savings accounts come with no account minimums, others such as Citizens Access will ask for a minimum deposit of $5,000.
Certificates of Deposit
A Certificate of Deposit, or simply a ‘CD’, is a short term investment product that requires you to lock your money away for a certain period of time. CD Accounts are typically offered by banks and credit unions, and the length of the term usually starts at 6 months, up to around 5 years.
As you will not be able to make a withdrawal without being financially penalized, CD Accounts can come with a slightly higher rate of interest in comparison to a conventional savings account. Moreover, you can earn a higher rate of interest when opting for a longer lock-up period.
If you’re only looking to put your money into a CD Account for one year, Marcus (by Goldman Sachs) is currently paying an APY of 2.25%. The minimum deposit is just $500, which is great. If you’re looking to keep your money locked away for even longer, a five year CD Account via Synchrony Bank will pay 2.45% APY, with a minimum deposit of $2,000.
Money Market Accounts
If you are looking for an FDIC-backed short term investment, but you don’t want to lock your money away for a fixed period of time, then you might want to consider the benefits of a Money Market Account. These operate in a similar way to a traditional savings account, albeit, you’ll earn a higher rate of interest.
Although Money Market Accounts come with a lower rate of return than a CD Account, you usually have the freedom of being able to access your money as and when you need to. Moreover, Money Market Accounts also come with a conventional debit card, subsequently offering the same freedoms as a standard checking account. On the other hand and unlike a checking account, Money Market Accounts usually require you to make a higher lump sum deposit.
Currently, BMO Harris is offering the most competitive Money Market Account, with an APY of 2.20%. Although the account does come with a fully-fledged debit card, you will be required to deposit at least $5,000. If $5,000 is too much for you, then you might want to consider State Farm. With a slightly lower rate of interest at 2% APY, the institution allows you to get started with just $1,000.
Short Term Bond Funds
If you’re looking for a more complex short term investment product, then it might be worth considering a short term bond fund. Although these operate in a similar way to a longer-term bond fund, the biggest difference is that short term funds usually mature in less than five years. The fund manager will subsequently buy and sell a range of government and corporate bonds during the term.
Once the term does mature, you will receive your original investment back, plus any gains that the fund (hopefully) makes. However, unlike the other short term investment products we have discussed so far, short term bond funds do not come with a fixed rate of interest. On the contrary, as you are speculating on the prospect of the fund manager making a profit, there is always the chance that you could get back less than what you originally invested.
Nevertheless, one of the best performing short term bond funds right now is that of the Vanguard Short-Term Investment-Grade Fund (VFSTX). Although the fund comes with an expense ratio of 0.2%, it pays an average return of 2.89%. Once again, although this is higher than what a CD Account or Money Market Account will pay, you are taking on an element of risk, albeit, a somewhat low risk at that.
Floating Rate Funds
A Floating Rate Fund is a short term investment product that sees the fund manager invest in a range of low-risk debt instruments or bonds. As the underlying interest available on the invested product can fluctuate in the open marketplace, so can your rate of returns.
Although there is an element of risk when investing in a Floating Rate Fund, the underlying instruments are typically low-risk. This can include US Treasury Bonds, stable corporate bonds, or low-risk institutional loans. One of the most popular Floating Rate Funds available in the market is that of the iShares Short-Term Corporate Bond ETF (IGSB), which targets an annual yield of 2.55%.
Peer to Peer Lending
If you have a much higher appetite for risk, then peer to peer lending might be worth considering. The peer to peer space allows you to lend your money to those seeking capital. This can either be to individuals or small-to-medium businesses.
Depending on the underlying borrower, peer to peer loans can pay anywhere between 4% and 12%, with higher rates of interest obviously coming with a higher level of risk. The reason that peer to peer loans are considered high-risk is that there is always the chance that the borrower will default on the loan.
If they do, this means that you might not get the full principal loan amount back. As such, if you do opt for the peer to peer route, you should diversify your risk by investing in dozens, if not hundreds of individual loans.
When it comes to the term of the agreement, this usually ranges from 18 months, up to around three years.
Treasury Inflation-Protected Securities (TIPS)
As we have noted throughout our guide, leaving your money in a traditional bank account will not only result in interest yields of sub-0.1%, but you’ll end up losing money when you factor in inflation. With that being said, Treasury Inflation-Protected Securities (TIPS) might be able to help if your primary goal is to protect your money from the threats of inflation.
TIPS operates in a very similar fashion to US Treasury Bonds, insofar that they are backed by the US Government. Moreover, you will receive interest payments every six months, with the amount depending on the current rate of inflation.
It is important to note that you will not actually grow your money in the truest form by investing in TIPS. Instead, your money will stay in-line with the rate of inflation at all times. This means that were a period of deflation to occur, your principal amount will go down.
Pay Off Student Loan or Credit Card Debts
The final short term investment that we would like you to consider is that of reducing your debt liabilities. Think of it like this. Let’s say that you have a lump sum of money and you decide to place it in a risk-free CD Account. In doing so, you might make 2% APY on your investment. As great as this is, what happens if you have outstanding debts on your student loan or credit cards?
The reality is that the interest payments on these debt liabilities will ultimately make your CD Account investment redundant. In other words, although on the one hand you are growing your lump-sum investment, your overall wealth is still going in the wrong direction for as long as you are required to pay interest on your debts!
With that being said, it is well worth considering targeting your debt obligations before engaging in a short term investment plan. In clearing your debts in their entirety, you can then proceed to realize your investment goals.
If you have read our comprehensive guide from start to finish, then you should now have a really good understanding of what short term investments are, how they work, and how they differ to longer-term investments. Most importantly, you should be able to make an informed decision as to whether or not a short term investment strategy is suitable for your personal investment goals.
One of the best things about short term investments is that they suit all risk levels. For example, if you have a very low tolerance towards risk, then you have the option of an Online High-Interest Savings Account, CD Account, or Money Market Account — all of which offer a fixed rate of return, as well as being fully-backed by the FDIC.
At the other end of the risk spectrum, you also have the option of higher-paying short term investment products such as peer to peer lending or short term bond funds.
As a final takeaway, it is also worth considering targeting your outstanding debt obligations before proceeding with a yield-paying financial instrument. Otherwise, although you might be earning interest, you’ll still be losing money when you factor in the interest payments that come with your debts!
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Founder of The Modest Wallet, Ricardo is an entrepreneur and investor who enjoys working out, spending time with his family and friends, travelling and creating great content. He’s passionate about helping others achieve their financial goals.