When you invest money for a short-term goal, taking extra risk is like playing with fire. Since you don’t know what might happen in the markets in the next few years, it’s best to keep things in perspective. The best short-term investments don’t lose you money when you need it most.
First, let’s define short-term as anytime in the next five years. This should give you a good idea of a time horizon that fits with a short-term savings goal like a vacation, home down payment, a wedding, or college savings.
Ultimately, you need to base your decision on your time horizon, the amount of money, and how much risk you’re willing to take. Though, I’d caution on overreaching for returns. The idea of taking more risk just to squeak out an extra tenth of a percent makes no sense. The last thing you want is to send little Joey off to college only to find out that your savings fell short because you lost money in the past year.
This doesn’t leave you with many short-term investment options. In one instance stocks are too unpredictable in the short-term for your low risk needs. And the abundance of low interest rates don’t help matters either. In these unusual times, sometimes its better to take the lesser of two evils.
In this case, the best short-term investments preserve capital first. So when its time to put that money to use, you still have enough to get exactly what you want. Any extra money leftover is a bonus. The five short-term investments below will help preserve your money and limit your investment risk.
CDs (Certificates of Deposit)
One of the most overlooked choices right now are CDs. Current CD yields are higher than treasuries with similar terms. This doesn’t say much for treasuries, but the added FDIC insurance and the multiple term options make it convenient for any length of time.
If you’re worried about interest rates rising, look for banks offering variable rate or raise your rate CDs. The alternative is to use a short duration CD that rolls over often enough to take advantage of rate changes.
You’ll find a wide range of CD yields, so take the time to shop around and compare rates and terms. Many banks will offer higher rates for larger deposits too. You can choose from our list of banks offering the best CD rates or check with your local bank or credit union.
Online Savings Accounts
If you’re just looking for a place to store money for a few months to a year, take a look at online savings accounts. Several online banks are offering savings account rates similar to what you’d get with a nine or twelve month CD. And you won’t have to lock your money up either.
That is just one of the benefits of online savings accounts. The other will keep your savings safe and secure just out of your spending reach. When you really the need the money transferring it back to a checking account is easy.
This includes online money market accounts. You can find banks offering higher rates for these accounts if the amount your savings is large enough. It’s worth checking local credit unions in your area too.
I Savings Bonds
If you’ve received a savings bond, an I Savings Bond is similar. The unique difference is I Bonds provide inflation protection. When you buy these bonds, the interest rate is made up of a fixed rate and an inflation rate. The fixed rate won’t change for the life of the bond, while the inflation rate adjusts every six months.
I Bonds are a great short-term investment but have several limitations. The most you can invest each year is $10,000 per Social Security number. There is a penalty for cashing out early. When you sell these bonds inside of the first five years, you lose the last three months of earned interest.
You can buy I Bonds directly from the Treasury at TreasuryDirect.gov.
Short Term Municipal Bond
If you’re in a higher tax bracket it might be worth buying individual municipal bonds. Notice I didn’t say municipal bond funds. There is a difference: a fund has a higher risk due to interest rate changes, where as an individual bond can be held to maturity.
This only works if the added tax benefit provides a better return. You use the taxable equivalent yield formula to find out. That link comes complete with a chart to make things easier.
There are limitations, though. Since municipal bonds are free from federal income tax, it’s entirely dependent on your marginal tax bracket. You’ll also have to find a high-grade municipal bond that fits your time horizon with a yield high enough to beat the other short-term investment options. Under the right circumstances the extra tax savings might be worth it.
Floating Rate Bond Fund
Floating rate bond funds are new and bring some risk and uncertainty. A floating rate bond is just like it sounds. It’s a bond with a variable interest rate. If rates increase, the rate on the bond will rise, but if rates fall, the rate on the bond falls. This makes the floating rate bond prices less volatile than a regular bond fund.
Since these funds are so new, the performance history is lacking. Honestly, not all companies that issue floating rate bonds have the best credit rating either.
If you’re adamant about taking more risks, the best suggestion is dividing your short-term investment between CDs and a floating rate bond fund to reduce that risk. But if you think interest rates will rise, this could offer some protection. Of course, so would a variable rate CD. You’ll need to decide if the extra risk is worth the slight reward. In the end it may only be a difference of 1% or less.
Keep In Mind
One of the big risks going forward is interest rate risk. One of two things will most likely happen in the near future. Either interest rates stay the same or interest rates rise. If interest rates don’t move, you have more flexibility with your options. But if interest rates rise, choosing the wrong investment option will leave you with losses. This is not an option. Focus on ways to lower risk or use it in your favor when you compare these options.