Short Term Investments
The Best Options for Temporary Cash
Investors with cash needed for near-term expenses often seek short term investments for temporary holdings. These provide a safe place to store liquid assets while generating modest returns exceeding savings accounts.
This guide explores popular short term investment options ranging from 3 months out to 5 years. It also covers best practices for aligning choices with your timeline and risk tolerance.
Let’s examine how to make your money work just a little harder during its short pitstop in your portfolio.
Overview of Short Term Investing
Short term investing involves temporarily placing money you need access to in relatively low risk securities for conservative growth over weeks, months or years. Here are some key characteristics:
- Time horizons from 3 months out to 5 years
- Goal of exceeding savings account rates with modest risk
- Favor highly liquid securities easily sold for cash needs
- Typically utilize safer, lower return fixed income products
- Lower potential returns than long-term investments
- Act as parking spot for funds needed later for planned expenses
Common short term investment assets include high-yield savings accounts, CDs, money market funds, short-term bond funds, high-quality individual bonds, and Treasuries.
These provide modest growth while filling the gap between long-term investments and idle cash in checking or traditional savings.
Why Invest Short Term?
Short term investing serves important purposes for funds not needed immediately or long into the future:
- Earn better returns than bank savings accounts and checking
- Keep assets liquid for known upcoming expenses
- House funds for emergencies that may arise
- Provide stability as you prepare for major near-term purchases
- Give temporary havens during volatile markets to buy assets low later
- Bridge gaps between other investments or market cycles
- Keep assets working with some growth while waiting to invest at better valuations
Short term investing is especially useful when markets turn volatile. Moving assets to less risky short term holdings prevents selling quality long-term assets at inopportune times until conditions improve.
Time Horizons for Short Term Investing
“Short term” is relative, but general guidelines on investment duration include:
3 months – Coincides with a quarterly period for funds held very temporarily.
6 months – Half a year timeframe for near-term savings goals.
1 year – Houses assets needed within the next annual period.
3 years – Funds that may go toward needs arising in the next few years. Still relatively cautious.
5 years – Maximum timeframe to still be considered short term focused before moving into intermediate territory.
Keep your time horizon for specific short term accounts in mind when selecting appropriate investments that align with when you’ll need the money.
Best Short Term Investments
Here are popular assets for short term investors favoring liquidity and wealth preservation:
High Yield Savings Accounts
High yield savings accounts offered by online banks pay significantly higher interest than traditional bank savings deposits, while still protecting your principal and providing FDIC coverage up to $250,000 per account. Rates fluctuate but commonly range from 3-6X higher than big bank savings products.
- FDIC insured
- Very low risk
- Liquidity via easy withdrawals
- Rates higher than traditional savings
- Rates still trail inflation
- Yields volatile as rates change
- Limited withdrawal access compared to checking
Best For Emergency funds, straightforward deposits.
Certificates of Deposit (CDs)
CDs lock in a fixed interest rate for a set period of time, ranging from 3 months out to 5 years. Early withdrawal incurs a penalty. Interest rates increase with longer maturities. Typical rates run from 0.5-3.0% currently depending on term.
- FDIC protection up to $250k
- Locks in fixed rate
- Almost no risk
- Lower liquidity with early withdrawal penalties
- Low rates compared to past decades
- Rate locked in only for CD term
Best For Medium-term savings goals with known time horizons.
Money Market Funds
Money market funds invest in very short-term, high-quality fixed income securities like government treasuries and commercial paper from banks. Their share price strives to stay at $1, but yields vary with interest rates.
- Daily liquidity
- Stable share prices
- Modestly higher yields than savings
- Not FDIC insured
- Floating returns fluctuate
- Minimum investments required for many
Best For Savings buffer earning slightly more than cash.
Short Term Bond Funds
Bond funds holding high quality bonds with average durations under 3 years provide conservative income. Short-term corporate, municipal, and treasury bond funds are common options. Yields range from 1-3%.
- Higher yields than money markets
- Low duration limits volatility
- Diversification across many bonds
- Not FDIC insured
- Some principal risk from bonds
- Bond funds can still lose value
Best For Enhanced yield for near-term savings with tolerable risk.
Brokered CDs function like traditional bank CDs but are sold through brokerages, allowing access to higher rates from smaller banks along with FDIC insurance on amounts up to $250,000.
- FDIC insurance
- Fixed rates like regular CDs
- Access to higher rates than banks
- Slightly lower liquidity than regular CDs
- Prone to some rate volatility
Best For Investors who shop around for the best CD rates.
Direct obligations of the U.S. government, Treasuries carry no risk of default. Short-term Treasuries include T-bills (maturities under 1 year) and short-dated T-notes (2-3 year range). Yields range from 1-4% currently.
- Extremely low risk
- Very liquid
- State tax advantages
- Lower yields than longer Treasuries
- Interest subject to federal tax
Best For Conservative savers who prioritize principal protection and stability.
Municipal bonds finance projects for states, cities, and municipalities. Interest is exempt from federal tax and sometimes state. Short-term muni bonds generally mature in under 5 years. Common yields range from 2-5%.
- Low risk
- Tax advantaged interest
- Stable source of income
- Lower yields than corporate bonds
- Some minimum investment requirements
- Research intensive
Best For Tax-savvy investors in higher brackets seeking tax-free income.
Factors for Choosing Short Term Investments
Consider these factors when selecting short term accounts and assets aligned with your needs and risk tolerance:
Time Horizon – Match duration and maturity dates to when you need the money.
Risk Tolerance – Accept only minimal risk over short windows. Prioritize stability and principal protection.
Liquidity Needs – Ensure no barriers to accessing funds like early withdrawal penalties.
Interest Rates – Compare yields across options, but don’t chase unsustainably high returns.
Taxes – Weigh taxable versus tax-advantaged interest income where applicable.
Diversification – Blend different short term assets like CDs, Treasuries, savings to avoid concentration risk.
FDIC Coverage – Stay under $250k per issuer if this insurance is important to you.
Other Goals – Account for considerations like credit building, relationship benefits, convenience.
Laddering Your Short Term Investments
“Laddering” refers to structuring a portfolio of short term assets so portions mature at different dates in the future.
For example, you might open 5 CDs at 6-month intervals, or purchase bond funds with short, immediate, and intermediate-term durations.
This provides continuous access to cash while allowing you to reinvest maturing assets at newer, possibly higher rates. Diversify your short term investments across the yield curve.
Risks of Short Term Investing
While short duration investments carry lower risk than stocks and other long-term assets, they still have potential downsides to consider:
Inflation Eroding Returns – Even the highest stable yields may not outpace inflation, slowly diminishing purchasing power.
Rising Rate Environment – Increasing rates across the yield curve means newer short term investments offer better yields than existing ones locked in at lower rates.
Tax Implications – Taxable interest is subject to ordinary income tax rates, reducing overall realized returns.
Early Withdrawal Penalties – Some products like CDs charge penalties for accessing funds before maturity, hurting liquidity.
Bond Defaults – Corporate and muni bonds carry risk of default, unlike guaranteed vehicles like Treasuries and FDIC insured bank products.
Opportunity Cost – Conservative short term investments often underperform riskier assets over longer periods.
Manage these risks by diversifying across various short term assets, allowing a portion in more liquid vehicles, and being willing to hold until maturity instead of liquidating early when possible.
Alternatives to Short Term Investing
Other options beyond traditional short term investments include:
Peer to Peer Lending – Invest in loans to individual borrowers seeking debt consolidation, business funding, etc. Yields from 5-12% but higher risk.
Real Estate Crowdfunding – Pool money with others to fund real estate projects for periodic income and appreciation upside. Higher yields but liquidity limitations.
Buy and Hold Dividend Stocks – Build a portfolio of stocks from blue chip companies with consistent, rising dividend payouts for income and modest growth.
Annuities – Insurance contracts providing guaranteed regular payments in return for an upfront investment. Useful for retirement income but complex products.
ETFs – Bond ETFs provide diversified short term corporate and government bond exposure. But prices fluctuate so principal may decline.
Target Date Mutual Funds – Retirement target date funds automatically adjust asset allocation from aggressive to conservative as the target year approaches.
These alternatives entail different risk-return tradeoffs compared to traditional short term investing options.
The wide range of short term investment choices allows selecting options tailored to your specific needs and risk tolerance given your timeline. Key principles include:
- Know exactly when you need the money and match short term asset maturities accordingly
- Focus on stability and principal protection over high yields
- Build a laddered portfolio of assets with staggered maturity dates
- Avoid tying up funds long-term in case needs change
- Diversify across both insured and uninsured vehicles to manage risks
- Monitor interest rates and reinvest maturing assets accordingly as yields change
With prudent selection, even temporary funds can work smarter for you without leaving cash sidelined or exposing it to excess risk. Determine your liquidity needs, risk comfort level, and time horizon to make short term investing decisions with confidence.