“I have a little cash in my bank account, and I’ll need to access it in under a year. Where can I invest it short-term for a better return than my checking account?”
I hear this question all the time. And the good news is that short-term investors have more options today than ever before. While often – but not inherently – safe, short-term investments typically yield lower returns than long-term investments.
Many of the options below are so safe, they’re guaranteed by the federal government. Others offer returns rivaling even long-term investments but come with an extra serving of risk as well. At the very least, you should be able to avoid losing money to inflation with little or no risk.
Here’s what all investors need to know about short-term investing before they park their money for under a year.
Before You Invest …
Before you make any investment decisions, take a close look at your debts. If you have any high-interest credit card debt or other unsecured debts, you may be better off using your extra money to pay these down rather than saving or investing it.
If you have a choice between paying 20% interest to a credit card or earning 2% interest on a CD, it’s a no-brainer to pay off your credit card debt. To do otherwise is to effectively lose 18% on your money.
Granted, if you know you’ll need to access the money in under a year, paying down debt may not be an option. That’s why it’s so important to understand your unique financial needs before committing money anywhere.
Goals of Short-Term Investing
Over a long enough time horizon, you can wait out the ups and downs of the market’s gyrations and corrections. Your priority is simple: Earn the highest return possible.
But in short-term investing, other needs often trump returns.
How quickly will you need to access your money? All deposit accounts let you access your money immediately, although some charge a penalty for early withdrawal. And some investments are easier to liquidate into cold, hard cash than others.
2. Not Losing Money to Inflation
If you weren’t worried about losing money to inflation, you’d just leave your cash in your checking account. But ultimately, every dollar you leave in cash loses money each year. Between 1914 and 2019, the average year saw 3.26% of value sapped out of each dollar, according to Trading Economics.
Investing money always involves some degree of risk, no matter how small. But when you fail to invest, you don’t risk loss; you guarantee it.
3. Not Losing Money, Period
When asked about his rules for investing, Warren Buffett famously answered: “The first rule of investment is don’t lose. And the second rule of investment is don’t forget the first rule. And that’s all the rules there are.”
That advice goes double for short-term investments. If you could afford to wait out market dips, you would invest long-term for a higher return. The fact that you’re even considering short-term investments suggests that you can’t afford to lose much, if any, money on them.
Safest Short-Term Investments
So what are some relatively safe place places to park your money if you need it back in within a year, without losing value to inflation? Here are nine options for short-term investments, in ascending order of risk.
1. High-Yield Savings
Savings accounts, including online and automated savings accounts, are insured by the federal government through the Federal Deposit Insurance Corporation (FDIC). Your first $250,000 is guaranteed secure.
Many banks pay nothing or almost nothing on savings account balances, but some savings accounts offer annual percentage yields (APYs) as high as 2.5%. That may not be much compared with stock or real estate returns, but it’s pretty impressive for a guaranteed secure account with no risk.
Check out the high-yield savings account from CIT Bank as an example; they also offer CD account options and a savings builder account that offers an even higher interest rate if you prefer (more on CDs shortly).
2. Money Market Accounts (MMAs)
A money market account (MMA) is similar to a high-yield savings account, but most require a minimum deposit and restrict withdrawals each month. Withdrawals can be limited based on the number of transactions, a specific dollar amount, or both.
That means they don’t offer the perfect liquidity of a savings or checking account. However, they remain more flexible and liquid than a CD.
If you’re a student or recent graduate new to investing and wary of any risk, money market accounts can be a safe way to start investing. Most money market accounts are insured by the FDIC, and some even offer the convenience of checks.
3. Certificates of Deposit (CDs)
Like savings accounts and money market accounts, most CD accounts are FDIC-insured and therefore extremely safe.
But unlike the other two, banks place strict limits on early withdrawals from CDs. When you deposit money in a CD account, you agree to leave it there for a certain period; it could be a matter of months or even years. The longer the maturity period, the higher the interest.
At the end of that maturity period, the bank releases your funds plus the agreed-upon interest. So if you know you only need to park your money for six months or a year, you can choose the length of maturity that best suits your needs, with full assurance that you’ll get your money back upon maturity.
Of course, life isn’t always predictable. If an emergency arises and you need to pull your money out early, expect the bank to hit you with stiff penalties. In other words, don’t put your emergency fund in a CD.
4. Treasury Bills (T-Bills)
Treasury bills are short-term bonds sold by the U.S. Treasury with maturity periods ranging from a few days up to a year. The longer the maturity period, the higher the interest, just like CDs.
When you buy T-Bills, you buy them at a discount from their face value. For example, if a T-Bill’s face value paid upon maturity is $1,000, you might buy it for $975, and then the Treasury pays you $1,000 for it when it matures.
You can buy T-Bills directly from the Treasury or on the secondary market through a brokerage account like Ally Invest. When they’re initially issued, the Treasury typically sells them in increments of $1,000.
Because they’re backed by the U.S. government, T-Bills are among the safest investments you can make. That said, they’re also among the lowest-paying. But they still often beat savings accounts, money market accounts, and CDs.
5. Treasury Inflation Protected Securities (TIPS)
If your primary goal is not to lose money to inflation, then Treasury Inflation Protected Securities (TIPS) are for you.
These U.S. Treasury bonds offer higher or lower returns based on the pace of inflation as measured by the consumer price index (CPI). When inflation increases, TIPS pay more, and when it decreases, they pay less.
Like the other options above, TIPS don’t pay particularly well, but you can at least protect your cash from losses to inflation. And while they originally sell for five-, 10-, or 30-year terms, you can buy and sell them on the secondary market at any time, making them more liquid than a CD.
6. Short-Term Bond ETFs
Actively managed short-term bond funds are exchange traded funds (ETFs) that invest in – you guessed it – short-term bonds.
The bond market introduces some volatility to your investment holdings, which adds risk for short-term investors looking to cash out in under a year. But because these ETFs only invest in short-term bonds, that volatility is limited.
As ETFs go, these funds tend to be low-risk, low-return investments designed to be safer and more stable than typical bond funds. And since ETFs are traded through a brokerage account like TD Ameritrade, you can sell them at any time to liquidate and access your money.
7. Municipal Bonds
While a city government is more likely to default than the federal government, the vast majority of city governments are good for the money you lend them. The risk is slightly higher for municipal bonds than Treasury bonds, but the yields are higher too.
This greater risk comes from interest rate fluctuations, rather than bond defaults. If interest rates rise and you need to sell before the bond matures, your bond will be worth less on the secondary market. But no one says you have to buy long-term municipal bonds. You can buy municipal bonds scheduled to reach maturity within a year if you’re worried about fluctuations in interest rates affecting your returns.
8. Arbitrage Funds
An arbitrage fund takes advantage of small differences in price, whether between shares of a company on two different stock exchanges or between the current cash price of a stock and its futures contract value.
The fund executes the purchase and the sale simultaneously, dropping the risk far below that of a typical stock fund. For example, say a company trades on both the New York Stock Exchange (NYSE) and the London Stock Exchange (LSE). On the NYSE, its stock is selling for $30.15 per share, but on the LSE, it’s selling at $30.30 per share. The fund buys shares at $30.15 apiece in bulk and simultaneously sells the same number of shares at $30.30 apiece, pocketing the difference.
One unique advantage of arbitrage funds is that they’re one of the few types of funds that perform better when markets see high volatility. More volatility usually means higher risk for stock investors, but not for arbitrage funds.
During periods of low volatility, arbitrage funds tend to invest more in debt, a more stable investment. If you want to invest in the stock market short-term and have a little risk tolerance, arbitrage funds are a great way to reduce risk in your stock portfolio.
9. Peer-to-Peer & Crowdfunding Loans
In peer-to-peer and crowdfunding websites, you provide the money for other borrowers’ loans.
To be clear, that’s also what happens when you deposit money in a bank account. The difference is that with a bank account, your money is insured by the FDIC, and you receive no or low interest on it. With a crowdfunding or peer-to-peer loan, you take on the risk of the borrower defaulting, but you earn a much higher return if they pay as agreed upon. Crowdfunding and peer-to-peer loans are short-term, typically anywhere from six months to five years.
Each investing platform is different, so vet them thoroughly before investing. For peer-to-peer loans, start by researching Prosper and LendingClub. If you’re interested in lending against real estate, try the crowdfunding website Groundfloor, where you can make short-term loans secured by real property paying between 5% and 25% returns. You can also invest in other businesses through Worthy Bonds. They offer a 5% return on all investments.
Bonus Idea: Invest Through Your Roth IRA
One other option to consider is investing money in a Roth IRA. With a Roth IRA, you can pull your contributions out with no penalty. You can even pull out some earnings for education or to buy your first home.
For example, you could contribute money to your Roth IRA and then invest it in an arbitrage fund or short-term bond ETF. It will earn some money for you over the next six months or year, and then when you need cash, you can sell and pull your original contributions back out. Your earnings will remain in the Roth IRA and keep growing tax-free for your retirement.
When you invest money for the short term, keep a close eye on your risk tolerance. Everyone’s financial needs and risk tolerance are unique.
Bear in mind that “short-term” doesn’t inherently mean “low-return” or even “low-risk.” The last thing you want to do is gamble the money for your tenant’s security deposit, your daughter’s college tuition, or any other bill with a looming delivery deadline. Aim for the best return you can get without putting imminently needed funds in danger.
What have your experiences been with short-term investments? Where do you like to park your money for a year or less?