What Are Short-Term Investments, and Which Types Are Best?
If you’re interested in entering the world of investments, you may be interested in exploring your short-term investment options, particularly if you want to try to make a quick return. Savings accounts, bonds, certificates of deposit, money market accounts — all of these are forms of short-term investments.
But what are short-term investments, exactly? Let’s dive into this topic and explore the many options investors have today.
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What Is a Short-Term Investment?
A short-term investment, sometimes called a “temporary investment” or “marketable security,” is an investment that is intended to be cashed out within three months to a year — though this can extend to upwards of five years, depending on the nature of the opportunity. A short-term investment generally serves two different (and sometimes simultaneous) purposes:
- To generate a quick return on investment.
- To serve as a safe place, ideally semi-profitable, for investment capital to yield smaller gains while an investor waits for larger opportunities to arise.
Companies may offer short-term investment opportunities in order to generate capital. This may be used to address debts, launch new products or initiatives, or achieve growth in other ways. Ideally, once the investment period has ended, their growth will enable them to pay investors back with a good return on investment (ROI). In the end, both parties benefit from this transaction.
Instances in which a company may be unable to pay investors back should be viewed as high-risk investments and must be approached with caution.
Short-Term Investment Options
Short-term investment opportunities can take many different forms. These are offered by different types of organizations and carry their own benefits and risks. As such, some may be more suitable for specific types of people. Read more about these options below:
A retirement fund as a short-term investment option? Well, yes — a Roth IRA can be an excellent choice for those who trade frequently with investment accounts and earn a lot in short-term capital gains. Because such earnings are typically highly taxed, using a Roth IRA as a home for your investment accounts enables you to make these earnings without reporting taxes on gains annually. Eventually, those funds may be withdrawn with no tax cost.
While this isn’t a typical short-term investment strategy, it may suit your specific needs. Explore your options to determine whether a Roth IRA fits your investment strategy.
Corporate bonds are sold for a set cost (typically in increments of $1,000) to individuals who are interested in earning interest on their investment until the bond matures, at which point investors can cash out. Optionally, investors can sell bonds before they mature, but this results in a less-than-ideal ROI.
Because this type of bond is contingent on the company’s ability to earn enough money to pay back investors, they generally carry some risk. While physical assets may be used as collateral, the simple fact of the matter is that the company may be unable to perform as expected financially, leaving investors shortchanged. Due to this risk, corporate bonds generally have high interest rates. Carefully weigh the level of risk you’re willing to take on before making this short-term investment.
Government bonds are like corporate bonds, except they involve lower risk and lower rewards. As the name suggests, they are backed by the government rather than a corporation. They are often issued to earn capital to complete government projects or fund daily operations. The U.S. Treasury handles government bonds in the United States, and it is perhaps the safest form of investment there is.
Given the stability of this type of investment, backers can rest assured they will receive their money back. Because of the lack of risk, however, the interest rate at which investors are paid is substantially lower. This is a smart choice for those unwilling to take on excess risk, but it can lock up your money for a minimal annual ROI.
Peer-to-peer lending (P2P lending) involves the use of an intermediary to match people who need to borrow money with people who have money to lend. These loans typically last three to five years. While this was traditionally limited to larger institutions, the digital age has introduced P2P lending websites that enable individuals to take advantage of this form of lending. Because such sites have fewer overhead expenses than more formal financial institutions, they are able to facilitate loans with lower interests.
While this is beneficial for individuals with poor credit who need money or people who want to diversify their investment portfolio, there are some risks to consider. Critics of P2P lending argue that it accrues far too many fees to be worthwhile for lenders.
Further, if a borrower does not pay, your chances of getting your money back go down drastically. Finally, a three- to five-year loan can also be prohibitive for those looking for short-term investment opportunities, locking up their capital for longer than they may desire.
Money Market Accounts
Money market accounts are very similar to traditional bank accounts, but there are some key differences between the two. They are bank or credit union accounts that accrue interest. While account owners can use debit cards and checks to access the account like a standard bank account, they are actually less flexible. Restrictions may include a mandatory minimum balance, fees for each use, and a limited number of transactions.
So why would you use a money market account? They have higher interest rates, often doubling the rate of a standard account. This an excellent way to earn some passive income, especially if you don’t need to make frequent payments from the account. However, if you want to be more active in your short-term investment strategy, you may want to explore other options.
Certificates of Deposit
Need to put some money away for a while? If you want to keep your money in a bank or credit union and have no intention of using it, a certificate of deposit (CD) may be a smarter option. CDs have even less flexibility than money market accounts, but they have even better interest rates.
There are several different types of these deposits. Here are some common examples:
- Brokered CDs: A CD offered through an intermediary. This involves some risk but may help you diversify your investment portfolio.
- Bump-up CDs: This type of CD starts at a low interest rate, but owners are allowed a one-time “bump up” to the rate. If rates go up, this is a smart option.
- Jumbo CDs: In return for keeping a higher minimum balance (generally $100,000, though some institutions offer jumbo CDs for amounts as low as $25,000), investors can earn a higher interest rate.
- Liquid CDs: These have lower interest rates but have more flexible terms, incurring no penalties for withdrawals.
- Step-Up CDs: This type of CD will see regular increases to its interest rate, often either annually or semiannually.
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This post was updated July 25, 2019. It was originally published July 26, 2019.