We often talk about long-term investing but what about investments when the clock is ticking? Long-term money can’t be treated the same way as short-term money.
You have to strike the right balance between being safe and making money. We’ll show you how to get the balance right with the best low-risk short-term investment options.
Short-Term vs. Long-Term
Just what do “short-term” and “long-term” mean regarding investing?
When it comes to evaluating market risk, your time horizon is a crucial factor to consider. As a general rule, shorter time horizons require more caution than do longer ones.
Short-term investments mean money you will need in five years or less.
Because you’re going to need this money relatively soon, you need to look at safe investments. No investment is without some level of risk, but some investments are indeed safer than others.
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While you can expect to make an average return of 9.00% (historical return of the S&P 500 from 2004-2023) in the stock market, short-term money won’t be invested long enough to average out through the market’s ups and downs.
Short-term money is typically for things like a down payment for a home, a planned renovation, or a wedding.
Long-term money is money invested for five years or more. This longer time horizon does allow for your money to ride out market fluctuations. Long-term money is invested for things like retirement or paying for a child’s college education.
The Best Short-Term Investments
You might think that the best thing to do with short-term money is to stick it in your checking or savings account.
While your money is undoubtedly safe there, it isn’t growing at all.
Of 13 well-known banks including Bank of America, Citibank, and Wells Fargo (no one should have a Wells Fargo account), none of them offer an interest rate above 0.20% on their checking accounts.
If you’re not sure what that means and just how shitty it is, if you had $1 million in a bank account earning that paltry 0.20%, your million bucks would earn $2,000. If you had that million invested in the market with a 7% return, it would earn $70,000.
You can get a slightly higher interest rate with a savings account but not much higher. Of 21 well-known banks, including some online banks, the best rate is 1.45%.
So no, leaving short-term money in a checking or savings account is not among the best investment options. Let’s take a look at some better places to park that money.
You might be surprised to see Betterment on this list of the best short-term investments, after all, the stock market can be risky.
But you can minimize that risk by setting a conservative allocation. The higher your percentage of stocks versus bonds, the more money you can make but the riskier your portfolio.
A conservative allocation of 50/50 stocks and bonds would allow your money to grow while still protecting short-term investors from a dip in the market.
A Betterment account set to 50/50 is appropriate for the money you’ll need in three to five years.
Yes, a Roth IRA is meant to be a retirement account, but you can use it as a short-term investment vehicle. Most retirement accounts penalize you for early withdrawal, but the Roth IRA doesn’t.
The account is funded with after-tax income so you can withdraw contributions, but not any earnings on those contributions, at any time, for any reason, and without penalty.
It’s not typically recommended because money in a Roth is meant to be used during retirement, but you may consider it worth it as a short-term investment because of the likely higher rate of return you’ll get from most other short-term investments. You can open a Roth IRA with Betterment or Vanguard.
Online Savings Account
Online banks often have higher interest rates than brick and mortar banks. If you’ve been to New York City in the last five years, you might suspect that half of Chase and Citibank’s profits go to rent.
There is one of each on seemingly every corner and not some poky little second-floor hovel either. Big, ground floor spaces on some of the most expensive real estate in the world.
Online banks don’t have brick and mortar locations, so they don’t have that expense. This is why they offer better rates.
That said, the rates still aren’t high, they don’t even beat inflation, but they are better than what physical banks are offering. Online banks often charge fewer fees too which is another bonus.
Two high-yield savings accounts are Synchrony and CIT Bank (check their sites for the lates interest rates).
An online savings account is best for the money you’ll need in two years, or less and accounts are FDIC insured up to $250,000 (per depositor) as they are with a traditional bank.
Money Market Funds
A money market account is sort of a cross between a checking and savings account. These accounts offer a higher interest rate than typical checking or savings accounts, and you can write checks from it. They usually have a high minimum balance requirement, usually around $2,500. If your balance drops below that, you may face a fee(see this article for low minimums).
A money market account is best for the money you’ll need in two years or less. These accounts are FDIC insured up to $250,000 if offered by a bank or credit union.
Certificate of Deposit
A CD locks your money up for a pre-determined length of time that ranges from three months to five years. The longer the time frame, the higher the yield. If you withdraw money before the date of maturity, you’ll be penalized. The penalty is typically the equivalent to three months worth of interest.
Check out CIT Bank’s offerings.
If you’re okay with your money being locked up for a period, certificates of deposit can offer higher yields than some of our other short-term investing options.
This investment is best for the money you’ll need in five years or less. Certificates of deposit are FDIC insured.
A Treasury Security is a U.S. government issued bond. Treasury bills have the shortest maturity periods, ranging from about a month to about a year. Treasury notes mature from two to ten years.
The yields on these bonds are lower than on every other type of bond because they come with almost no risk, making them a very safe investment. The rates vary by the length of the maturity period.
These investments are best for the money you’ll need in five years or less. While you can buy Treasury notes for ten-year terms, ten years is well outside our definition of short-term.
Short-Term Bond Funds
A short-term bond fund invests in bonds that mature in five years or less. The bonds can be issued by any entity including the U.S. government, companies, and corporations. You’ll need a brokerage account, with Ameritrade or ETRADE for example, to invest in these funds.
These funds typically pay lower interest rates but potentially higher yields than money market funds. Given the extra hassle of going through a brokerage account coupled with interest rates that aren’t much better than a standard savings account, I’ve only included short-term bond funds as an available option, but it’s certainly not the best choice on this list.
But if you insist! Short-term bond funds are best for the money you’ll need in one to two years.
Municipal bonds are sold to finance state and local infrastructure projects. One of the most attractive features of these investments is that the interest income from them is exempt from federal taxes.
If you buy bonds in your state of residence, the interest may be exempt from state and local taxes as well.
In most cases, longer is better regarding investing, but that’s not true of municipal bonds. Those with a duration of one to two years are more insulated from interest rate stimulation than longer-term investments.
You can buy these bonds directly from the municipality or through a bond mutual fund. An investment in municipal bonds is for the money you’ll need in
Lending Club is an example of a peer-to-peer lender. It’s the company we chose to focus on as Andrew has direct experience investing with them.
The platform pairs lenders with borrowers. By providing investors with the ability to purchase consumer debt, Lending Club can offer better rates for borrowers as well as higher returns for investors.
In addition to being able to buy individual loans in chunks as small as $25, investors can also have their funds automatically invested based on their unique specifications.
Lending Club investments range from three to five years. Your rate of return depends on how much risk you’re willing to take when choosing loans to fund. Andrew has made returns of more than 18%!
This short-term investment is the riskiest but highest yielding which is pretty much how all investing works. It’s best for the money you’ll need in three to five years.
Pay Off Debt
If you have high-interest credit card or student loan debt, you should ignore everything on this list and focus on paying that debt off. No money you can make on any short-term investments or long-term investments is going to be more than you’re paying on high-interest debt.
Credit card debt is the most urgent. The average rate is in the mid-teens and often much higher. Make a plan to attack the debt.
Use the snowball or stacking method to pay it off efficiently. If your credit score is good enough, you may be able to qualify for a balance transfer credit card. This will allow you to pay off the principle more quickly because it’s not accruing additional interest.
Again, if you have decent credit, you may qualify for a loan with Lending Club. You can take out a single loan with a lower interest rate than your credit cards have and use it to pay off the balances.
Student loan debt interest is typically relatively low, but if you can make it even lower, you can pay the debt off more quickly and start investing. Even a 1% reduction in your interest rate can save you thousands of dollars over the life of the loan.
You can refinance your student loan debt with Credible. The average customer who refinances with Credible saves an astounding $30,939! You can check your interest rate in two minutes and doing so won’t affect your credit score.
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You Have Choices
LMM gets at least one email a week from a listener who is torn between safe investments for their short-term money and leaving it sitting in a savings account where it’s safe but making less than 1% interest.
While there is no safe short-term investment that is going to match an average market return, you do have better options now than that crummy savings account.