Do you have some extra cash laying around in a savings account? If so, you should consider a short-term investment strategy to allow your money to grow.
Do you have some extra cash laying around that you are looking to invest, but you may be a little passive on the stock market? Or, maybe you don’t need the money right this second, but you know it will be a possibility soon. These are two prime scenarios for short-term investments.
What exactly is a short-term investment? In most cases, this is an investment that is meant to last anywhere from one day up to three years. There is no exact science to a timeline, but typically the money you invest is something you plan to need or use sooner rather than later.
For the IRS, a short-term investment is anything the you hold for less than one year, as far as capital gains are concerned. Anything over one year would fall into the long-term investment category for capital gains. An important part of a short-term investment is making sure you can liquidate to cash quickly. Meaning your investment can be turned into cash in your savings account within hours or up to a few days.
While the stock market has historically given 10 percent annual returns, that math becomes much less volatile over longer periods of times. If you try to get in the stock market for a short period or even day trade, there is far more risk involved and your chances of losing are much higher. Some experts have gotten rich doing this, but some beginners have lost it all the same way.
If the situation is right, short-term investments can be a great option, even though the returns are typically less than a longer-term investment. Remember, anything is better than the garbage interest rate you are getting by your money sitting in a savings account.
- When to Utilize Short-Term Investments
- Types of Short-Term Investments
- When Not to Utilize Short-Term Investment
When Should you Utilize Short-Term Investments?
Short-Term Investments are not the answer for everyone. Remember, these returns will end up having far less returns than a long-term investment. What’s the benefit of using short-term investments then, you may ask? If you are in a situation where you need access to liquid cash quickly, then this is your solution.
I hate to say it, but the least valuable asset you can have right now is cash. Savings accounts are paying .01 to .06 percent interest, while many other investments are giving back double digit returns if you play your cards right.
How do I utilize short-term investments? I keep a limited amount of cash in my savings, literally enough to pay for one major catastrophe in my life. A furnace going out, a major car issue, or an unexpected medical bill. Other than that, my typical savings account money is tied up in short-term investments.
Why use short-term investments? One – I’m typically getting anywhere from two to five percent returns, which is far better than interest in my savings account. Two – if I ever need the money, I know I can liquidate it quickly with only paying taxes on my earnings.
Let’s say you have $30,000 in a savings account. At .05% quarterly interest that is $6 a year you would earn back in interest. If you would keep $10,000 in your savings and invest $20,000 and only earn three percent on short-term investments, you would have made $1.50 from your savings, and $600 on the short-term investments. The reason is right there in the math. I will admit, I use a brokerage account for my short-term investments which is a little more risky, but as you get more comfortable, it has the most upside (as well as risk).
Another prime situation to use short-term investments is when you are saving up for something big. It could be the down payment for a house, a new car, a wedding, or even furniture for your house that you want to pay for in full. Putting the money in short-term investments until you are ready to proceed, and then liquidating it when you need the cash for a payment is a great strategy.
Another great perk of using a short-term investment is it really makes you think about spending the money. If the money is in your savings account, it’s really easy to just swipe a credit card or withdraw it out of the ATM without even thinking about it. If you must go into your account, make a trade, and then move the money back to your savings account, it just gives you more time to think about it. When the money isn’t visible to spend, it’s easier to pass on things in my experience.
I know, it doesn’t make a ton of sense when you say it out loud, but it really is a benefit for me. I can have cash within two hours for most of my short-term investments, but it still makes me think long and hard before pulling the trigger on a purchase.
Types of Short-Term Investment:
Now that you understand when utilizing a short-term investment makes sense, let’s look at the different types you can utilize and what may make the most sense for you. There are five different options of short-term investments that I want to cover today.
Money Market Accounts
An extremely low risk option for short-term investments is a money market account. This is just a glorified savings account that will provide a higher interest rate than a standard savings account.
The only catch to a money market is there is typically a minimum investment involved. Keep in mind, you will want to make sure you have the minimum plus whatever you think you may need in the future. So, if $5,000 is the minimum and you have $8,000 in the account, you only have $3,000 of liquid cash available.
It’s worth noting, the interest rate on a money market account is higher than savings accounts, but it’s still likely going to be lower than inflation. If you take that into account, your money will still be losing value, just not as much as a savings account.
Short Term Bonds
There are two low risk bond options as well. One is a government bond, which is basically a loan to the government. In return for your money, the government pays you back a small amount of interest.
The good thing about a government bond is it’s fully protected, and you can’t lose. The bad news, the return isn’t much higher than a standard savings account so your investment will still have returns that are quite a bit lower than inflation.
A corporate bond is the second option and it’s identical to a government bond, with the only difference being that it is backed by a specific corporation vs. the government.
Corporate bonds do have more risk because they aren’t backed by the government, but still tend to be an extremely safe short-term investment option that you can get out of any day the financial markets are open.
Certificates of Deposit
A certificate of deposit (CD), is another short-term investment option to consider. However, this is an option where there is a penalty if you want to take your money out early.
A CD is another form of a loan to the government over a certain period of time. Typically, the CD lengths are three months, six months, and one year. The longer that you loan the money to the government, the better the return.
You can find CD’s that have no penalty clauses, however they typically just become a government bond at that point with a limited return.
Interest rates are low across the board at the moment which makes CD’s not as attractive at the moment, but years ago these accounts could almost compete with stock market returns. If you invest in a CD, it needs to be money you won’t need during that time. You will be forced to pay penalties if you don’t meet the time commitment.
On one side a CD has a better return than the previous two options, but the flexibility to get your money is not as good. CD’s are backed by the government which means you can’t lose if you don’t take your money out early.
Another option for short-term investments would be your typical brokerage account where you trade stocks. Now, this can come with more upside, but that also means there is more risk involved.
Unlike a retirement account, a brokerage account can be fairly liquid. Typically, if I move cash to my checking account, I can have access to it within 24 hours. Do keep that in mind, it is not an instant cash option like some of these short-term options we have discussed.
Over time, the history shows that your typical brokerage account should yield you 10 percent growth in a year. Keep in mind that the 10 percent theory is much more accurate the longer the investments are made.
For example, you could easily invest $1,000 in a stock and it turn into $1,100 within a month or two. You could also invest in a stock that drops to $800 within a day or two as well. The stock market is much more volatile than any of the other options we have discussed.
What does that mean? If you are interested in short-term investments with a brokerage account, you either need to make sure you won’t ever need cash quickly or think about investing in major corporations with a higher dividend and lower return.
I’ll never forget my encounter with Netflix (NFLX) when I was in college, the stock was on a terror in early 2014. I bought in at just over $61, but then decided I wanted to get a new car for my first job I would be starting later that spring.
I forced myself into a corner and sold at just over $46 per share and took a massive loss to come up with my down payment. I only had the stock for about 30 days, and if I would have held onto it for a year or more, I could have doubled my money. To make myself really sick, I looked at the stock today and it’s up over $500 on the daily.
Cash Management Account
Another option for short-term investments would be a cash management account, or a robo-managed account. This is a type of brokerage account, but you have very limited control over where your investments are going.
When you sign up, you pick whether you want short-term, long-term, aggressive, or low-risk investments and they do the work for you.
This is good and bad. For me, I always like to pick the trades myself no matter what type of investment I’m making. However, if you are new or just don’t have the time to manage, this could be a great option.
This is another strategy that can be liquidated fairly quickly (typically 24-48 hours), and it can be tied directly to a checking or savings account. That means you can direct deposit whenever you want or set it up as an automatic payment.
The one thing to remember: make sure there aren’t any fees associated with your cash management account. I have read a few horror stories of people dumping $5,000 in an account, not paying attention, and then realizing they lost some value because of all transaction fees.
Above are five great options for short-term investments. Remember, these aren’t the only available options, but they are the five best in my opinion. It all comes down to exactly what your needs are.
If you have some cash laying around and are just tired of it growing at extremely low interest rates given by a bank, you’ll want to investigate corporate bonds, certificates of deposits, or a brokerage account. These options give you the ability to access money quickly, and can have higher return opportunities, especially if you let the money sit for at least 12-months.
If you are looking for a short-term investment opportunity and need absolute flexibility on the liquidity of your money, a government bond, high yield savings account, or money market account may be the best option for you.
These options may not provide a return that can outperform inflation, but it’s still better than what a savings account is able to provide you right now. The big takeaway from all of this: short-term investments are a great opportunity for you to take advantage of. Let your money do the work for you.