f you’re looking to invest money for the short term, you’re probably searching for a safe place to stash cash before you need to access it in the not-so-distant future. The volatile markets and slumping economy in 2020 led many investors to hold cash as the coronavirus crisis continued — and 2021 has remained uncertain, too, as the economy attempts to bounce back.
As a result, you’ll want to ensure you have that cash when you need it, instead of squandering the money on a potentially risky investment. So the most important thing investors should be looking for in a short-term investment is safety.
What is a short-term investment?
If you’re making a short-term investment, you’re often doing so because you need to have the money at a certain time. If you’re saving for a down payment on a house or a wedding, for example, the money must be at the ready. Short-term investments are those you make for less than three years. You’ll sacrifice a potentially higher return for the safety of having the money.
If you have a longer time horizon – at least three to five years (and longer is better) – you can look at investments such as stocks. Stocks offer the potential for much higher returns. The stock market has historically risen an average of 10 percent annually over long periods – but it has proven to be quite volatile. So the longer time horizon gives you the ability to ride out the ups and downs of the stock market.
Short-term investments: Safe but lower yield
The safety of short-term investments comes at a cost. You likely won’t be able to earn as much in a short-term investment as you would in a long-term investment. If you invest for the short term, you’ll be limited to certain types of investments and shouldn’t buy riskier assets such as stocks and stock funds. (But if you can invest for the long term, here’s how to buy stocks.)
Short-term investments do have a couple of advantages, however. They’re often highly liquid, so you can get your money whenever you need it. Also, they tend to be lower risk than long-term investments, so you may have limited downside or even none at all.
Overview: Top short-term investments in November 2021
Here are a few of the best short-term investments to consider that still offer you some return.
1. Savings accounts
A savings account at a bank or credit union is a good alternative to holding cash in a checking account, which typically pays very little interest on your deposit. The bank will pay interest in a savings account on a regular basis.
Savers would do well to comparison-shop savings accounts, because it’s easy to find which banks offer the highest interest rates and they are easy to set up.
Risk: Savings accounts are insured by the Federal Deposit Insurance Corporation (FDIC) at banks and by the National Credit Union Administration (NCUA) at credit unions, so you won’t lose money. There’s not really a risk to these accounts in the short term, though investors who hold their money over longer periods may have trouble keeping up with inflation.
Liquidity: Savings accounts are highly liquid, and you can add money to the account. Savings accounts typically only allow for up to six fee-free withdrawals or transfers per statement cycle, however. (The Federal Reserve has allowed banks to waive this requirement as part of its emergency interventions in the market.) Of course, you’ll want to watch out for banks that charge fees for maintaining the account or accessing ATMs, so you can minimize those.
2. Short-term corporate bond funds
Corporate bonds are bonds issued by major corporations to fund their investments. They are typically considered safe and pay interest at regular intervals, perhaps quarterly or twice a year.
Bond funds are collections of these corporate bonds from many different companies, usually across many industries and company sizes. This diversification means that a poorly-performing bond won’t hurt the overall return very much. The bond fund will pay interest on a regular basis.
Risk: A short-term corporate bond fund is not insured by the government, so it can lose money. However, bonds tend to be quite safe, especially if you’re buying a broadly diversified collection of them. In addition, a short-term fund provides the least amount of risk exposure to changing interest rates, so rising or falling rates won’t affect the price of the fund too much.
Liquidity: A short-term corporate bond fund is highly liquid, and it can be bought and sold on any day that the financial markets are open.
3. Money market accounts
Money market accounts are another kind of bank deposit, and they usually pay a higher interest rate than savings accounts, though they typically require a higher minimum investment, too.
Risk: Be sure to find a money market account that is FDIC-insured so that your account will be protected from losing money, with coverage up to $250,000 per depositor, per bank.
Like a savings account, the major risk for money market accounts occurs over time, because their low interest rates usually make it difficult for investors to keep up with inflation. In the short term, however, that’s not a significant concern.
Liquidity: Money market accounts are highly liquid, though federal laws do impose some restrictions on withdrawals.
4. Cash management accounts
A cash management account allows you to put money in a variety of short-term investments, and it acts much like an omnibus account. You can often invest, write checks off the account, transfer money and do other typical bank-like activities. Cash management accounts are typically offered by robo-advisors and online stock brokers.
So the cash management account gives you a lot of flexibility.
Risk: Cash management accounts are often invested in safe low-yield money market funds, so there’s not a lot of risk. In the case of some robo-advisor accounts, these institutions deposit your money into FDIC-protected partner banks, so you might want to make sure that you don’t exceed FDIC deposit coverage if you already do business with one of the partner banks.
Liquidity: Cash management accounts are extremely liquid, and money can be withdrawn at any time. In this respect, they may be even better than traditional savings and money market accounts, which limit monthly withdrawals.
5. Short-term U.S. government bond funds
Government bonds are like corporate bonds except that they’re issued by the U.S. federal government and its agencies. Government bond funds purchase investments such as T-bills, T-bonds, T-notes and mortgage-backed securities from federal agencies such as the Government National Mortgage Association (Ginnie Mae). These bonds are considered low-risk.
Risk: While bonds issued by the federal government and its agencies are not backed by the FDIC, the bonds are the government’s promises to repay money. Because they’re backed by the full faith and credit of the United States, these bonds are considered very safe.
In addition, a fund of short-term bonds means an investor takes on a low amount of interest rate risk. So rising or falling rates won’t affect the price of the fund’s bonds very much.
Liquidity: Government bonds are among the most widely traded assets on the exchanges, so government bond funds are highly liquid. They can be bought and sold on any day that the stock market is open.
6. Certificates of deposit
You can find certificates of deposit, or CDs, at your bank, and they’ll generally offer a higher return than you could find in other bank products such as savings accounts and money market accounts.
CDs are time deposits, meaning when you open one, you’re agreeing to hold the money in the account for a specified period of time, ranging from periods of weeks up to many years, depending on the maturity you want. In exchange for the security of having this money in its vault, the bank will pay you a higher interest rate.
The bank pays interest on the CD regularly, and at the end of the CD’s term, the bank will return your principal plus the earned interest.
Risk: CDs are insured by the FDIC, so you won’t lose any money on them. The risks are limited for a short-term CD, but one risk is that you may miss out on a better rate elsewhere while your money is tied up in the CD. If the interest rate is too low, you may also end up losing purchasing power to inflation.
Liquidity: CDs are less liquid than other bank investments on this list. When you agree to the terms of the CD, you generally allow the bank to charge you a penalty for ending the CD early. So you want to be extra careful that you don’t tie up your money and then end up needing to access it before the term is over.
7. Treasurys
Treasurys come in three varieties – T-bills, T-bonds and T-notes – and they offer the ultimate in safe yield, backed by the AAA credit rating of the U.S. federal government. So rather than buying a government bond fund, you might opt to buy specific securities, depending on your needs.
Risk: As with a bond fund, individual bonds are not backed by the FDIC, but are backed by the government’s promise to repay the money, so they’re considered very safe.
Liquidity: U.S. government bonds are the most liquid bonds on the exchanges, and can be bought and sold on any day the market is open.
8. Money market mutual funds
Don’t confuse a money market mutual fund with a money market account. While they’re named similarly, they have different risks, though both are good short-term investments. A money market mutual fund invests in short-term securities, including Treasurys, municipal and corporate debt, as well as bank debt securities. And since it’s a mutual fund, you’ll pay an expense ratio to the fund company from the assets being managed.
Risk: While its investments are generally safe, money market funds are not as safe as money market accounts, which are FDIC-backed. In contrast, money market funds can lose money, typically only in periods of severe market distress, but they are generally quite safe. Still, they are some of the most conservative investments available and should protect your money.
Liquidity: Money market mutual funds are reasonably liquid, and you can access your money readily. They may allow you to write checks off the fund, though you’re typically limited to six withdrawals per month.
Best investments for short-term money
| WHEN YOU NEED THE MONEY | INVESTMENT OPTIONS | POTENTIAL INTEREST RATE | RISK |
|---|---|---|---|
| A year or less | Savings and money market accounts, cash management accounts | Around 0.5 percent | Low risk and accounts are backed by the FDIC. |
| Two to three years | Treasurys and bond funds, CDs | 1+ percent | Bank products and Treasurys are safest, corporate bond funds slightly less so. |
| Three to five years (or more) | CDs, bonds and bond funds, and even stocks for longer periods | 1.25+ percent (or much more if you’re investing in stocks) | CDs and bonds are relatively low risk compared to stocks, which can fluctuate a lot and are high risk. |
What makes a good short-term investment?
Good short-term investments may have many things in common, but they are typically characterized by the following three traits:
- Stability: Good short-term investments don’t fluctuate too much in value, as many stocks and bonds do. The money will be there when you need it, and is often protected by FDIC insurance or a government guarantee.
- Liquidity: A good short-term investment usually offers high liquidity, meaning that you can access the cash invested in it quickly. In the case of certain investments such as CDs, you’ll know when the money becomes available, and you can always redeem the CD, though it will often come with a penalty.
- Low transaction costs: A good short-term investment doesn’t cost a lot of money to get into or out of, unlike a house, for example. That’s especially important when yields on short-term investments are at historical lows.
These features mean that your money will not be at risk and will be accessible when you need to use it, which is one of the major reasons to have a short-term investment. In contrast, you can earn a higher return on long-term investments but must endure more short-term volatility. If you need that money, though, you might have to sell at a loss to access it fully.
Tips for investing money for 5 years or less
If you’re investing money for five years or less, you should have a different process than if you were investing with a time horizon of decades. Instead, you need to approach short-term investing with the following tips:
- Set your expectations. Short-term investments will have lower potential returns than long-term investments, so it’s important to set your expectations appropriately.
- Focus on safety. In general, if you’re investing for the short term, you should focus on safety rather than return. Your money should be there when you need it.
- A little extra return may not be worth the extra risk. With short-term investments earning so little, it can be easy to try to get a little extra return at the expense of a lot more risk. But focus on why you’re investing for the short term.
- Pick the investment based on your needs. You might be able to earn a little extra on that CD, but what if you need to access the money before it matures? Calibrate your investment type to your needs.
- Not all short-term investments are equal. Bank products are backed by the FDIC, so you won’t lose any principal. But market-based products, even safe ones like short-term bond funds, could decline over short periods. Understand the risks of your investments.
Short-term investments are usually pretty safe, especially relative to longer-term investments such as stocks or stock funds. But be sure you understand what you’re investing in.
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