Key points
- Short-term investments provide low-risk places to park your cash.
- They tend to offer lower returns than riskier investments.
- Short-term investments include high-yield savings accounts and CDs.
Investing is key for long-term wealth generation. But what if you don’t have decades to ride out the stock market’s ups and downs? Keeping your money in a bank account that earns less than the inflation rate is akin to losing money daily. The interest you earn won’t keep pace with the rising costs of living.
So how can you generate returns without taking on too much risk? The right answer may be one of the best short-term investments.
What are short-term investments?
Short-term investments can be converted to cash quickly. They usually mature within three years. But some financial experts define short-term investments as those that mature within 12 months. Short-term investments also tend to be relatively stable, with little to no volatility in price.
They’re often used for emergency savings or near-term expenditures. You can also use short-term investments to offset the volatility of riskier portions of your portfolio.
“Short-term investments are like the flexible, fast-moving players in your financial game plan,” said Nicholas Yeomans, a certified financial planner and president of Yeomans Consulting Group Inc. “Think of them as your financial MVPs for quick wins and easy access to cash when you need it most”
Pros and cons of short-term investments
Short-term investments have a lot to offer. But they aren’t right for every goal or investor.
The main benefit is knowing you’ll take on reduced risk compared to investing in equities or other risky investments. “Specifically, regarding fixed-income investments, you are reducing your duration risk, which essentially means limiting adverse consequences due to interest rate volatility,” said Andrew Briggs, director of portfolio management at Plaza Advisory Group.
Pros
Some benefits of short-term investments include:
- Reduced risk. Short-term investments are less risky than many long-term options. This provides a degree of security for investors.
- Predictability. Short-term investments often provide fixed and regular income. You know ahead of time what you’ll earn and when.
- Principal protection. Some short-term investments promise to return your principal after a set period. There’s no risk of losing it.
Cons
Short-term investments aren’t without their drawbacks. These include:
- Lower returns. Short-term investments tend to offer lower returns than longer-term investments and those with higher risk profiles.
- Inflation risk. Short-term investments may not keep pace with inflation, leading to purchasing power erosion.
- Reinvestment risk. Interest rates could fall before the investment matures, forcing you to reinvest funds in a lower-yielding security.
Best short-term investments
There are many short-term investments, which is helpful when finding the right one for your needs. But the options can also be overwhelming. How do you choose?
One strategy is to match the investment’s expected cash flow to your income needs, Briggs said. Let’s say you need $6,000 in five years but have only $5,000 today. You could choose a five-year certificate of deposit paying 5% interest. This would net you just over $6,000 in five years.
If you need access to your money sooner, there are other options. You may want to use a high-yield savings or money market account. Depending on the terms, you may be able to tap your funds more frequently.
Yeomans said to think of choosing a short-term investment like selecting a suit for a special occasion: It must be tailored to fit both you and the circumstances.
“You should evaluate the return offered, the liquidity terms as well as your potential for loss of principal,” said Omar Qureshi, managing partner of Hightower Wealth Advisors in St. Louis. Short-term investments are typically safer than many of their longer-term counterparts. But there may still be a risk of loss or reduced earnings, depending on the product you choose.
With that in mind, here are some of the best short-term investments.
High-yield savings accounts
There’s no technical definition of a high-yield savings account. But the term is generally used to describe the highest-earning savings accounts on the market. Current high-yield savings rates are over 10 times the national average savings account rate reported by the Federal Deposit Insurance Corp.
High-yield savings accounts are often found at online-only institutions. Their low overhead costs mean they generally offer lower fees and higher interest rates.
Institutions may impose withdrawal limits in exchange for the higher yield. For example, you may only be able to make six withdrawals per month. Anything above that would incur a fee. But you can add funds anytime.
Another potential drawback is that the annual percentage yield you earn may fluctuate. Other short-term investments on this list offer fixed-interest rates that don’t change and are more predictable.
High-yield savings accounts are usually FDIC insured up to $250,000.
Certificate of deposits
Certificates of deposit are short-term investments that offer fixed interest rates. When you open a CD, you agree to leave your money at an institution for a predetermined period. You earn the stated APY during this time. Withdrawing your money before the maturity date may result in a penalty.
CD terms can range from days to months or years, making them great for a laddering strategy, where you open CDs with varying maturities. This lets you keep some money in “securities (that) mature in the near term while increasing duration in another portion to combat reinvestment rate risk,” Briggs said.
You usually can’t add funds until the CD matures. At this point, you can renew the CD at current rates or take your cash and put it elsewhere.
There are different CD types, including:
- High-yield CDs, which pay the highest APY.
- Jumbo CDs for large chunks of cash; they usually require a $100,000 minimum deposit.
- Raise-your-rate CDs, which increase your APY if interest rates rise during your term.
The rates on short-term CDs are typically comparable to high-yield savings accounts. But CDs provide reassurance that your rate won’t change — unless you select a raise-your-rate CD. CDs are usually FDIC insured up to $250,000 if held at a covered institution.
Money market accounts
Money market accounts are savings accounts at banks or credit unions. They usually pay higher rates than other savings accounts. They do so by investing your cash in short-term, low-risk investments like U.S. Treasury bonds and CDs. A great benefit is that the bank or credit union bears the risk of these investments. In other words, your funds won’t lose value, even if an issuer defaults on a CD.
Like high-yield savings accounts, MMAs may come with withdrawal restrictions. But they generally apply only to check, debit card and electronic transactions. You can usually make unlimited ATM withdrawals.
Unlike CDs, MMAs don’t have a lock-up period. But CDs may offer higher rates. You may also need a minimum initial deposit to open a money market account.
Money market accounts are usually FDIC insured at banks. They’re also covered at credit unions by the National Credit Union Administration up to $250,000.
Cash management accounts
A cash management account is like a hybrid checking and savings account. You get the accessible features of a checking account, such as a debit card and check writing. What’s more, it generally comes with higher returns than a savings account. You may also be able to invest the money you keep in a CMA. But note that if you invest your funds, you bear all the investment risk.
CMAs usually have minimal, if any, fees. But there may be fees associated with the securities you invest in within the account. Your funds are also typically insured up to $250,000 by the FDIC or Securities Investor Protection Corp.
CMAs are offered by various financial institutions, from investment firms to robo-advisors.
Short-term bond funds
Short-term bond funds invest primarily in bonds with maturities of three years or less. They can own dozens or even hundreds of bonds, which helps diversify your short-term investments.
Funds may invest in different types of bonds, such as U.S. Treasury or corporate bonds. They can be structured as mutual funds or exchange-traded funds. They often have an expense ratio. This annual fee compensates the manager for overseeing the fund.
Funds earn interest on the bonds they hold. They then pass these payments to investors through regular distributions. The amount of income you receive from the fund is expressed as the yield. Your fund’s share price may also rise over time, earning you capital appreciation. But this is likely to be only modest growth.
Bond funds aren’t FDIC insured. They may, however, be covered by the SIPC if you purchase them through a covered institution. Like stocks and mutual funds, you can purchase bond funds on the stock market. You can find them for as little as $1.
Treasury bills
Treasury bills are short-term bonds issued by the U.S. government. They have maturities ranging from four to 52 weeks.
Instead of earning regular interest, Treasury bills are sold at a discount to their face value. When the bill matures, you receive the full face value. For example, you could purchase a Treasury bill with a face value of $1,000 for $975. You’d receive $1,000 at maturity. The difference between the discounted price you pay and what you receive at maturity — $25 in this example — is the effective interest rate.
These securities are backed by the U.S. government. So they’re often considered among the safest investments available. As a result, they tend to pay lower interest rates than higher-risk municipal or corporate bonds.
You can purchase Treasury bills at TreasuryDirect.gov or on the secondary market through a broker. You can also sell your Treasury bill before it matures. You might receive less than the principal, however, depending on the market price.
Treasury bills aren’t FDIC insured. But they’re effectively just as safe since the government guarantees them.
When should you consider a short-term investment?
Short-term investments can serve a role in your portfolio. But they aren’t always the best choice.
“Short-term investments are for money you need to keep safe and stable, and for expenses tied to goals that will occur in the near future,” Qureshi said. “They can also provide comfort to those with higher-risk, longer-term portfolios that are subject to fluctuations.”
But they usually aren’t the right move for long-term savings. The returns are often much lower than what you could earn with riskier investments.
You should consider short-term investments for money you’ll need within the next five years. “Whether it’s saving for a new car, a dream vacation, a medical procedure or tackling pesky credit card debt, short-term investments can be your secret weapon for success,” Yeomans said.
Julie Sherrier contributed to the reporting of this piece.
Frequently asked questions (FAQs)
Where you should invest $5,000 short term depends on several factors. Consider your goals, risk tolerance and when you’ll need the funds. High-yield savings accounts, CDs, money market accounts, cash management accounts, short-term bond funds and Treasury bills are all solid short-term investment options.
Short-term investments can generate income. But it may be less than the income you can earn from longer-term investments. The degree of risk you’re willing to accept will also impact how much income the investment generates.
The best short-term investments include high-yield savings accounts, CDs, money market accounts, cash management accounts, short-term bond funds and Treasury bills. Each provides varying returns, degrees of risk and access to your money.