Anything you buy for the purpose of making more money can be considered an investment. With that said, investments can be divided into two groups — long-term and short-term. This article will help you gain an understanding of the fundamentals of short-term investment options.
When it comes down to it, the goals of any investment should be twofold: produce revenue and appreciate in value. Investment instruments can include stocks, bonds, real estate, artwork, fine wines, exotic automobiles or anything that could appreciate.
A key aspect of understanding any investment is an awareness of the degree of risk it entails. After all, there is always a chance an investment might not increase in value as expected and it’s entirely possible that it could lose some or all of its value. This risk/reward analysis is the basic difference between saving and investing.
Saving is putting money in a safe place with the intention of adding to it for a future need. Meanwhile, investing uses money to realize a gain over time. Thus, the growth of a savings account is primarily reliant upon your ability to make additional deposits, while the growth of an investment is dependent upon its performance.
Given the risk factor, e.g. the possibility of loss, associated with investing, it is reasonable to ask why anyone would do so. After all, saving — as a means of growing wealth — is a process over which you have more control. Savings grow each time you add to them and the risk of losing your money in a traditional savings account is all but eliminated.
However, investing offers you the potential for greater rewards in exchange for accepting the accompanying risk of loss. Thus, gains derived from investing can outpace those of saving — particularly when you take inflation into consideration. Prices for goods and services tend to trend upward over time, which can make the value of cash diminish in a commensurate fashion.
Meanwhile, inflation has the potential to increase the value of a good investment. Further, the principle of compounding also helps an investment grow. Reinvesting the earnings derived from an investment raises its value, which positions that investment to earn even more and grow at a faster rate than before.
Your primary consideration as an investor should be the purpose(s) for which you are investing. In other words, what are your associated financial goals?
Generally speaking, long-term investments serve the need for large sums of money in the distant future, while short-term investments are better suited for the funding of a more immediate need. Are you investing for the purpose of enjoying a month-long vacation in the Maldives within the next three to five years, or are you working toward retiring comfortably in 20 to 30 years?
Other factors you need to consider before starting out as an investor include:
• The amount of money you’ll need to accomplish your goal(s)
• The tax implications of the resulting earnings
• How soon you’ll need access to the money
• How long you’ll need the money to last
• Whether you’ll invest a lump sum, or smaller amounts on a regular basis
• Your tolerance for risk
As discussed above, long-term investments are better suited to the achievement of goals with a distant time horizon. Because investments tend to become more valuable over time, you can also afford to take on more risk with a long-term investment, as it will have room to recover from the ups and downs the market will typically experience along the way.
On the other hand, short-term investments are typically less volatile because you need to protect your investment capital more vigorously. You’re going to need the money sooner, so you need to do what you can to make sure it will be there when you need it, even as you do the best you can to make it grow.
In this way, short-term investments are slightly more like savings accounts, because you need your investment capital to maintain a degree of accessibility (liquidity) — while gaining as much growth as is feasible over the duration of the investment. Again though, lower risk usually translates to less reward, so it’s important to keep that in mind with a short-term investment.
Some of the most attractive elements of a typical short-term investment tend to be safety, easy liquidity and the potential for a greater return than you could derive from a traditional savings account. Typical short-term investments keep your principal close at hand should an immediate need arise. Moreover, the risk of one of these investments going into default is generally going to be lower than the risk you’d take on with a longer-term investment.
They also provide a degree of insulation from volatility and the returns are typically greater than those you’d derive from a bank or credit union savings account. Another benefit of most short-term investment options is low transaction costs. You can get into them at minimal cost and selling out of them is relatively inexpensive too.
Some common short-term investments include:
Certificates of Deposit (CDs) – Insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000, these time deposits are issued by banks and pay a higher rate of interest in exchange for your agreement to grant the bank usage of the cash over an agreed-upon timeline. Yields are tied to the amount of time you allow the bank to hold on to the money. FDIC-insured means your deposits are guaranteed up to the deposit insurance amount, making them a relatively safe short-term investment option.
Money Market Accounts – Also FDIC-insured, money market accounts work like CDs, but require a specific minimum investment amount, which varies from account to account. Money market accounts typically pay a lower rate of interest than a CD, but you can get out of a money market account sooner and with less bother.
Money Market Mutual Funds – Investing in short-term securities, as well as bank, corporate and municipal debt, money market mutual funds differ from money market accounts in that they are not FDIC insured and you’ll pay an asset management fee. Basically an income-oriented mutual fund, your dollars are invested in short-term debt along with those of a group of other investors. While considered to be among the most conservative of investments, money market funds can potentially lose money.
High Yield Savings Accounts – With interest payments higher than the traditional bank savings accounts — high yield savings accounts also enjoy FDIC protection. However, the financial institutions that offer them usually don’t provide standard checking and savings accounts, which means one stop banking probably won’t work.
Treasurys – Government-issued bonds, bills, floating rate notes and Treasury Inflation-Protected Securities (TIPS) indexed to inflation fall into this category. These are backed by the credit rating of the United States government, so they tend to be quite safe.
Short-Term Corporate Bond Funds – Purchased from asset managers and investment companies, these short-term investments do entail a bit more risk, but they tend to pay better as well. Composed of a collection of bonds across different industries, their volatility tends to be low.
Municipal Bonds – Favored for their tax-free nature, buying a municipal bond is essentially loaning money to local, state or non-federal government agencies in exchange for the promise of financial gain when the bonds mature.
Cash Management Accounts – Offering the ability to invest in a broad range of short-term investments, cash management accounts work a lot like regular bank accounts in that you can write checks against the value of your investment, as well as transfer cash into and out of them.
Funds are pools of capital owned by a group of investors, in which each individual owns shares in proportion to the amount of money they invest. The advantage of a fund is the ability it provides to get in on a wider array of investment opportunities with smaller amounts of capital.
Funds come with a manager, so you also get the benefit of professional investment expertise. Investment fees are lower too, as they are shared among the participants in the fund. Types of funds include money market funds, mutual funds, money market mutual funds, low-cost index funds, bond funds and exchange traded funds (ETFs).
The latter offer a higher degree of flexibility in that they are priced and available for trading on a daily basis. In other words, while ETFs operate largely like the other types of funds listed above, they can be bought and sold day by day (intraday). ETFs also usually have lower associated costs than mutual funds.
Bank deposit accounts combine the attributes of checking and savings accounts, while earning higher rates of interest than regular interest bearing accounts. Guaranteed by the FDIC, your funds (both principal and accrued interest) are safe in bank deposit accounts up to $250,000 per person, per bank. While the rate of return varies, it almost always trails the rate of inflation, making bank deposit accounts unsuitable as long-term investments.
Another type of deposit account is the company deposit. This is basically affording a specific company use of your money in exchange for a fixed rate of return over a certain period of time. The risk here is company deposits are unsecured, which means your money can be lost if the company encounters financial difficulty.
To reiterate, the beauty of short-term investment options is they offer an opportunity to grow your money in situations in which you’ll need to use it sooner rather than later.
With that said, certain types of short-term investments are better suited for a given set of circumstances than others. In most cases, your best option will come down to the amount of time you have to let the investment work for you.
One to Two Years – Online savings accounts, money market accounts and cash management accounts are good choices when you’ll need to access the money in two years or less. These are very low risk, which in turn means they are also low reward. However, their average return is about 0.5%, which is better than the 0.06% average you’ll get from a traditional savings account.
Two to Three Years – With a time horizon of two to three years, your best play will likely be short-term bond funds or money market mutual funds. These entail moderate risk and deliver an average return of 1-2%.
Three to Five Years – Given three to five years with which to work, bank certificates of deposit (CDs) can provide returns of around .75% to 1% in the case of CDs.
Any investment other than the traditional trinity of stocks, bonds and mutual funds is considered an alternative investment. These are best looked upon as one aspect of a portfolio, rather than a sole investment strategy. In other words, they are generally best employed for diversification. Alternative investment options include fine art, wine, collectible automobiles, hedge funds, private equity and real estate.
Formerly open only to investors with extremely high net worth, platforms such as Yieldstreet have opened these alternative opportunities to everyone. As an example, Yieldstreet’s Short Term Note Series XL requires a minimum investment of $500 and promises a return of four percent or better over the course of six months. Moreover, its interest payments are disbursed on a monthly basis and there are no management fees.
Used to pre-fund Yieldstreet’s future offerings, the company has funded $225M in investments through this program over 38 offerings, 31 of which were repaid in full at maturity. The primary goals of Yieldstreet’s Short Term Notes Series are to meet liquidity needs with terms of less than six months, while achieving yields surpassing those of money market funds and CDs.
Getting started is as easy as registering for an account and qualifying for accredited investor status.
As we discussed earlier, short term investing and long-term investing have decidedly dissimilar purposes. Therefore, your approach should also be different when you’re investing in something for five years or less.
These tips will help you find more success at short-term investing.
1. Know What to Expect – The potential for return is much lower with short-term investments. Going into one thinking you’ll come out with a huge gain is unrealistic. You’re better off thinking of a short-term investment as a savings plan with an elevated rate of return over the traditional bank or credit union savings account.
2. Protect Your Capital – With your cash out horizon closer, you’ll need to do everything possible to be sure you’ll come out the other side with your principal intact and something of a gain. With that in mind, your focus should be on the safety of the investment, more so than the size of the return.
3. Balance Risk Against Reward – You might be tempted to push just a bit farther to get in on a larger payout. However, the golden rule of investing is the higher the payout, the more significant the risk. This is why it’s important to be clear about why you’re investing to ensure your strategy matches your need.
4. Needs Dictate Actions – Yes, that CD will pay out a full percent, while the yield of the money market account will be half a percent less. However, that CD will be of much less benefit if you need to get to your money in two years as opposed to five because you’ll have to wait for it to mature. In this instance, the liquidity of the money market account makes it the advantageous short-term choice.
5. Understand The Risks – Bank short-term investments such as CDs, money market accounts and high yield savings accounts offer Federal Deposit Insurance Corporation protection. This means your principal will be covered if the bank defaults. Meanwhile, other types of short-term investment have no such protective mechanism in place. Do everything you can to come to grips with the associated risk, so you can determine if the investment is worthwhile for your purposes.
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