With the S&P500 index reaching all-time highs above the 3,000 level, and the American economy reaching its strongest position in over a decade, everyone is talking about investing in the stock market.
However, equities present a significant amount of risk to any would-be investor that decides to get their feet wet in the market. In reality, you don’t need to invest in stocks to have a secure financial future and a comfortable retirement. While returns in the markets can be substantial, they can also leave you with your head in your hands after sustaining a colossal loss.
If you’re interested in investing, then there are plenty of other low-risk, short-term investment options to get you started on the road to financial prosperity.
When deciding on an investment strategy, there are two primary strategies; short and long-term:
- Long-term investors look for growth opportunities where they can lock-up their money for 10, 20, or even thirty years.
- Short term strategies focus on investments in the 1 to 5-year range.
In this article, we’ll focus on short-term investments you can use to grow your money.
Savings Accounts and Money Market Accounts
Let’s start with the basics.
Savings accounts and money market accounts are a popular choice for short-term investors with low-risk tolerance and a need for liquidity in their investments.
Savings accounts are available from banks and select private investment firms. You deposit a minimum amount, typically $2,000, and you start earning interest on your money at an annual return set by the financial institution.
In most cases, the APY on your investment is minimal, and won’t keep up with inflation – but it’s better than leaving your money in a checking account where it’s earning nothing.
Money market accounts also offer low-yields on your cash, but they are FDIC insured, and a relatively low-risk investment.
One of the best features of both types of accounts is that you can readily access your cash whenever you need it, without incurring any penalty fees.
Read: What is a Money Market Account? Complete Guide
As Good as Saving – Pay Off Your Debt
Do you own credit cards, student loans, auto loans, or a mortgage? If so, then paying off your debt should be your top investment priority before you think about putting your money into the markets.
Credit facilities with a high APR, (Annual Percentage Rate), are costing you money if you don’t pay them off as quickly as possible.
Some personal loans may have an APR of between 14 and 18-percent, with credit cards costing you anywhere between 18 and 24-percent, depending on your credit score.
Reducing your exposure to this type of high-interest debt is as good as saving. If you’re paying an 18-percent APR on your credit card, and want to invest into an asset yielding 5-percent or less, you could be putting the money into paying off your debt, rather than making a low return that isn’t even contributing to the interest on your outstanding debt.
Certificate of Deposit (CDs)
Certificates of deposit are available from financial institutions that are looking to raise capital to strengthen their financial position. CDs are available from banks and come in a variety of term lengths, from three months to 5-years to suit your short-term strategy.
When you open a CD, you’re committing to pay the bank a stipulated amount every month for the duration of the investment period. The bank relies on your incoming payments to bolster their cash position, enabling them to lend out more money in the form of loans and other financial vehicles, such as mortgages.
- CDs are a safe investment with very low-risk. The Federal Deposit Insurance Corporation, (FDIC) insures all CDs. This insurance means that if the bank collapses, such as Lehman Brothers did in 2008, then you get your deposits back from the Federal government.
- CDs pay an annual interest rate, known as APY (Average Percentage Yield). This interest payment compounds during the term, allowing you to benefit from earning interest on your deposit, as well as interest on the interest you earn. Compound interest is one of the great secrets of wealth, and what starts as a small deposit and interest payment, snowballs into a significant return over the investment term.
- CDs are a great way to commit to a savings plan, but they also come with risk. When you take out a CD, you’re committing to pay a monthly deposit, every month, until the maturity of the contract. If you withdraw your money from the CD before the maturity date, then you can expect to pay a hefty penalty fee for doing so.
Therefore, if you lock your funds up in a CD, and find a higher-yielding short-term investment, you won’t be able to withdraw your money from the account, unless you want to incur these penalty fees.
When banks calculate the APY on your CD, it’s typically below the prime interest rate. Banks take the money you place into your CD and loan it to other people at a higher interest rate. The banks make money on the spread between what they are paying you for your money, and the price at which they loan it to other consumers.
Therefore, a CD will always yield less than the prime rate. While the Federal Reserve states that inflation is at their mandated target of 2-percent, consumer price inflation is far higher. Anyone who shops at the grocery store can tell you that prices continue to rise, even though inflation is at record lows.
Thus, you can expect your CD to fail to keep up with real inflation, slowly eroding the value of your money over time. However, CDs still yield far more than you would get with a traditional savings account.
Read: What is a Certificate of Deposit? (CD) Complete Guide
Municipal Bonds Vs. Government Bonds
The international bond market is an attractive low-risk investment for long-term investors. In this case, the investor purchases treasury notes and earns interest on the money they loan to the government. Government bonds are popular as a “safe-haven asset,” among institutions, and they flock to them to avoid volatility in the stock markets and other risky investments.
However, the interest investors earn on government bonds is subject to capital gains tax. Therefore, they may not suit short-term investors that don’t want to share a portion of their investment gains with the government.
Government bonds also have a relatively low yield, as they are attached to the Federal Funds Rate, which is currently a paltry 2.5-percent.
The Federal Reserve is set to reverse its current course of monetary policy, from a tightening phase to an easing environment where they cut rates. Therefore, you can expect yields on government bonds to decline over the next policy cycle, which could last 4-years or longer.
If you hold government bonds during this period, and the Fed cuts rates to zero, or negative territory, you could end up paying the government to loan them money – and that’s not an ideal investment strategy.
However, municipal bonds, or “muni’s,” are an attractive alternative to government bonds, and they carry a much higher interest rate.
These bonds are free of any capital gains taxes, and you get to keep all of the money you make on the investment.
If you are in the high-income tax bracket, then municipal bonds offer a great place to park your money in the short-term, allowing you to benefit from tax-free gains on your investment.
Read: What are Bonds? The Complete Beginner’s Guide
Short-Term Bond Funds
Bond funds are an excellent way to gain exposure to the bond market. These funds pool investors’ money into a managed account, where the fund manager uses it to invest into a diverse range of bonds, including government bonds, muni’s, and debt markets in emerging economies, known as the “junk bond” market.
Financial institutions, such as investment banks and hedge funds, rely on these bond vehicles as a short-term safe-haven to reduce investors risk when investing in other high-growth assets, such as the stock market.
However, most bond funds don’t offer more interest than you would get with a standard savings account. CDs will also beat bond funds on their APY as well.
ETFs and Mutual Funds
Exchange Traded Funds, (ETFs), and mutual funds, give a short-term investor exposure to a variety of markets, from debt to precious metals, as well as stocks and bonds. You invest your money with a financial firm, such as Fidelity or Vanguard, and they pool your money into a central account overseen by a senior account manager.
When setting up an ETF or MF, you select your level of risk exposure, allowing you to invest in high-risk assets, such as emerging market debt, or low-risk assets, such as the gold market. High-risk portfolios typically have much higher yields than those with low-risk exposure. As a result, you earn more money if you select a high-risk strategy.
ETFs and MFs may or may not have term sheets and penalties for withdrawing your funds early, so it’s best to check with your advisor before entering into these investments. ETFs and MFs also have exposure to global markets, regardless of their risk strategy. Therefore, if there is another global financial crisis, you may take a substantial loss on your money.
Most ETFs and MFs also struggle to make returns that beat inflation, and you could end up seeing your money lose its purchasing power over time. However, this is not always the case, as some fund managers are more talented than others.
Before you commit to either one of these investments, it’s a prudent move to shop around for the best performing funds to maximize your returns. However, it’s also important to note that as managed investment products, both MFs and ETFs are subject to fees and expenses related to managing the fund. The manager needs to get paid, and the institution needs to make annual profits to satisfy the shareholders.
Some of the more prominent funds may offer higher returns, but also stick you with higher fees for their services. Therefore, make sure you take your time researching the terms and conditions, as well as the performance.
Read: What is an ETF? The Complete Beginner’s Guide
Robo-Advisors
With the rise of the internet, robo-advisors are becoming a popular trend among young investors. We’ve already discussed the issues of costs related to investment forms managing your money, and paying fund managers to look after your investments.
Robo-advisors circumvent the need for a fund manager. Instead, they rely on computer algorithms to select stocks, bonds, and other financial investments that are top performers. As a result of not needing a fund manager, you pay less in management fees.
Robo-advisor accounts are also reasonably liquid, meaning that they act in a similar manager as a savings account, allowing you to withdraw a part or all of your investment at any time, without incurring penalties and other fees related to an early exit. Therefore, if you need liquidity in your investment portfolio, a robo-advisor account can be beneficial to your investment goals.
Robo-advisors work similarly to ETFs and mutual funds, allowing you to select your risk exposure. You can ask the advisor to choose a high-risk or low-risk portfolio to meet your risk tolerance and investment objectives.
Read: What are Robo Advisors & Which are The Best Ones?
Peer-to-Peer Lending
If you’re comfortable with taking on more risk in your investment portfolio, then peer-to-peer lending is an excellent choice. Peer-to-peer lenders allow you to create an account with a financial firm specializing in micro-loans or small loans to the consumer market.
You place your money into the fund, and the company lends it to the public. The most significant benefit of using this investment vehicle is that it provides a steady monthly cash-flow on your investment from the duration of the investment period.
Gains on peer-to-peer lending investments may yield as much as 8-percent or more, making them far superior to other strategies mentioned so far in this review. However, while you’ll receive a monthly cash flow from your investment, you won’t be able to access your capital amount until the end of the investment period. Therefore, your capital is locked up in this investment until it reaches the end of the investment period.
If you’re willing to trade off liquidity for higher returns, then peer-to-peer lending is a viable short-term investment option to grow your money.
Read: Best Peer to Peer Lending Sites
In Closing – Manage Your Risk
When starting your entry into the world of investing, its vital that you understand your risk tolerance. Some investors are comfortable putting their money into high-risk assets, with the hope of making a higher return. However, if the thought of losing money starts to give you a panic attack, then consider investing in low-risk assets and funds.
1 Comment
I am glad after reading your concept upon short term investment process. This helped me a lot for future investment process.