Although the returns on short term investments are usually low, they offer greater access, liquidity and security than long term investments such as stocks, bonds, real estate, and hard assets (gold or silver). While some of the best short term investments don’t pay much more in returns than your piggy bank, they are FDIC insured, making them a safer place for your money with the added benefit of yielding some kind of return greater than 0% interest. The following is a list of the best short term investments, as well as pros and cons of each to consider before investing your money.
Checking and Savings Accounts
Most market-competitive banks like Chase, Wells Fargo, Citibank, and Bank of America will pay interest on checking accounts; however, you’ll probably never notice the difference in your balance because the interest rate is likely .05%, if not less. Credit unions, on the other hand, will likely offer a higher yield, but not by much, at about .10% to .20%, which is one of the reasons I’ve always maintained both credit union and commercial bank accounts. To learn more, check out our article on credit unions vs. banks.
If you are looking for higher interest-bearing accounts where inflation won’t erode the purchasing power of your money, you may have to shop around for a free online checking account from an online bank, such as Ally Bank, ING Direct, Discover, EverBank, USAA, or Perkstreet Financial. Online banks tend to have higher interest rates on savings accounts than local institutions, so if you don’t mind no-frills service with cash back rewards, online accounts may be a good investment choice.
These online accounts usually require very low minimum balances, are FDIC insured and the money can be accessed anytime with checks or ATM cards. Interest rates are still low when compared to other investments, such as CDs or Treasuries, and may not keep pace with the rate of inflation, but the purpose of these accounts is to facilitate transactions and any return is better than no return. After all, what’s the alternative – keeping money in your mattress?
Money Market Accounts
Typically, these accounts pay more interest than checking accounts, but less than standard savings accounts and online-only banks and accounts. Unlike checking and savings, these accounts have a minimum balance that must be maintained. The money is readily available and can be withdrawn at anytime without penalty with a check or debit card.
Like other bank accounts, money markets are FDIC insured up to $250,000. One advantage and disadvantage is that the annual percentage rate (APR) is tiered, so most banks will offer .10% for balances between $0 to $2,499, .15% for balances between $2,500 to $9,999, .25% for amounts $10,000 to $49,999, up to maybe .50% for balances $100,000 and over.
However, consider this: if you have a $100,000 or more sitting in a money market account, why aren’t you investing that amount elsewhere and yielding a much greater return? Even a very liquid and easily-accessible high-yield online bank account returns close to 1%, and if you aren’t earmarking the funds towards a down payment for a house or any specific investment in the near future, trade in the benefits of access/liquidity for returns using a CD.
Money Market Funds
Similar to money market accounts, money market funds are sold by brokerages and mutual fund companies. MM funds are invested in low risk securities like CDs, government bonds and commercial paper (short term debt issued by corporations). The shares are usually priced at $1.00 each, which is the net asset value (NAV), and returns are higher than those of money market accounts. These funds are liquid, you can access your money with checks or ATM cards, and issuers rarely let the NAV drop below $1. The downside is that, unlike bank accounts, money market funds are not FDIC insured.
Certificates of Deposit (CDs)
Certificates of deposit (CDs) are available at banks for periods of 3 to 60 months. The longer the investment period, the higher the interest rate paid by the financial institution. CDs are very low risk investments and are insured by the FDIC, but they are not as liquid as savings, checking or money market accounts since your money is off-limits for the period of time it is invested. There are penalties for early withdrawal, usually three months interest, so if you know you will need the money before the certificate matures, it may be better to choose another investment.
U.S. Government Notes or Bills
The difference between government notes and bills is that Treasury bills mature in less than one year and Treasury notes are issued for between 2 and 10 years. These bills and notes are considered the safest investments in the world because they are backed by the full faith and credit of the United States government. Even better, they can be bought commission free at TreasuryDirect.gov. The returns on treasuries are exempt from state and local taxes, but there are penalties for early withdrawal, which means you might not get back all of your original investment if you cash in before the Treasury note matures. Unfortunately, the cost of low risk investments is low returns, so you may find that other investments offer a better risk-adjusted return.
Another type of security issued by the U.S. government, I Bonds are inflation-indexed savings bonds, which means the rates of return are adjusted semi-annually to keep up with inflation. Very secure and exempt from local and state taxes, I Bonds are available in denominations of between $50 and $10,000. They can be bought at banks, financial institutions and at TreasuryDirect.gov.
When “I Bonds” are used to finance a college education, the returns are exempt from income tax. Earnings are tax-deferred for up to 30 years, so these are also a good retirement investment to protect against long term inflation risk. I Bonds cannot be redeemed until they are held for 12 months and penalties for early withdrawal apply if the bond has been owned less than 5 years.
Only federal government bills and notes are a more secure investment than municipal bonds (“munis”), which are issued by local and state governments to finance public projects like roads, bridges, parks, public buildings, and other infrastructure projects. The returns on these bonds are exempt from federal income tax and may be exempt from state and local taxes.
One disadvantage of “munis” is they are not as liquid as other investments and you may lose part of your initial investment if you cash in a bond before it matures. Interest rates on munis tend to be quite low and are a favorite of high-income investors looking for ways to limit their tax-liability.
Corporate bonds are issued by private companies and returns vary depending on the risk and credit rating of the individual company. Creditworthy companies pay lower returns on the bonds than companies that have a higher level of risk, which is what investors refer to as “investment-grade bonds” and “junk bonds”, respectively.
While corporate bonds usually pay more than secure investments like government securities, CDs and money markets, investors can lose part or all of their investment if the company suspends interest payments or goes bankrupt. Investors who cash in bonds before they mature may lose part of their initial investment and many brokerage firms charge a commission when they sell corporate bonds.
Bond funds pool the money of many investors and buy different types of bonds of differing grades and quality. Each investor buys shares of the fund that offers a more secure investment than individual bonds through diversification. The share price on bond funds can fluctuate which can mean losing part of the original investment and returns on bond funds also vary over time. Investors pay loads (commissions) when buying the shares and an ongoing fee called an expense ratio for owning shares in the bond fund. Consumers interested in bond funds, which are a type of mutual fund, can learn more about the advantages and disadvantages of mutual funds.
Whole Life Insurance
Although most people do not consider a life insurance policy an investment, a whole life policy is a financial instrument that offers liquidity, security and tax advantages. There are many different types of whole life insurance options to meet the needs of different investors and their financial goals. While returns on whole life insurance are low, a minimum return is usually guaranteed and money in the policy can be accessed with a no-interest loan. The policy remains in force and if the insured person dies before the loan is repaid, it is deducted from the death benefit.
Yes, an IRA is a retirement account, but it can also be a good short term investment vehicle. Unlike other retirement accounts, the Roth IRA is funded with money that has already been taxed. While you cannot withdraw the returns earned on the account without penalties, you can withdraw your initial contributions or “starting capital”. So if you want to save for retirement, but still keep the money available for emergencies, a Roth IRA may be the right choice for a short and long term investment.
Roth IRAs can be invested in ETFs, stocks, bonds, and mutual funds to earn a higher yield and it may take two business days to get cash from your account, meaning the cash isn’t immediately accessible but not exactly illiquid either. Just beware of all rules and regulations regarding IRA withdrawals to avoid any penalties and fees.
Pay-Off High Interest Debt
Have $5,000 to invest and $5,000 in credit card debt with an APR of 20%? You will actually get a better return on your money by paying off your credit cards than you can earn on nearly any short term investment. If you are paying an annual interest rate of 20% on your credit card debt and are paying it off slowly each month, while sitting on cash in your bank account earning .10%, you would be crazy not to take the money and pay off the credit card as soon as possible.
Not only that, paying off credit cards will buff up your credit score so you can get lower interest rates when borrowing money in the future. While this may not seem like an investment, the money you save in interest can be put into savings or other investments every month.
High Risk Short Term Investments
Property Tax Certificates
Purchasing property tax certificates at auction from municipalities or counties allows the investor to collect the amount of the taxes owed on the property plus an interest rate set by the government entity that sold the certificate. If a property owner fails to satisfy the lien within a specified period, the certificate holder may have the right to sell the property. Purchasing liens can be risky since the property may be in poor or un-sellable condition and the investor can lose all or part of his money.
Additional risks include being unable to evict a tenant or owner without lengthy and costly litigation, or the property being trashed before the previous owner flees in the middle of the night. On the flip side, returns on properties sold at auction can be 100% or more of the original investment. Property tax certificates are only for those people who can afford to take a significant loss and understand the risks and benefits of the process.
Peer to Peer Lending
Peer-to-Peer lending websites allow investors to connect with qualified consumers who need to borrow money. Individual investors become part of a group that act as a lending institution and each investor receives a monthly income in loan repayments and interest. While returns on shares of Peer to Peer lending organizations are usually higher than many other investments, returns are not guaranteed and investors can lose money if too many borrowers default. This investment is not as easily exchanged for cash as some others, since investors must sell their shares to recoup their investment.
Short Term Investments
The right short term investment depends on the individual investor. Investors should research opportunities that look promising before deciding where to put their money. High yield investments always come with higher risks, so before choosing the best short term investment for their needs and financial goals, individuals should compare the pros and cons of each and the amount of money they are willing to risk or lose. If the answer is none, stick to secure investments like savings and money market accounts or government notes.
Just a side note: Similar to checking, money market accounts, CDs and other investments, the rate of interest paid for certain financial products is indirectly tied to the Federal Reserve’s fed funds rate. The fed funds rate is the rate banks charge each other for overnight loans to temporarily satisfy their reserve requirement (cash reserve ratio). When the Federal Reserve lowers this rate, it lowers the cost of borrowing. Though consumers benefit from cheap mortgage rates, they are also paid less interest on their bank deposits. Considering the Federal Funds Rate is near 0% right now and will remain there for the foreseeable future, earned and paid interest payments will remain low.