I recently gave an investment presentation to a group from a trade association. One question I got was: “I want to save up for a down payment. How can I do this without much risk? And I don’t want to just put my money in a bank savings account.”
Well, I mentioned that she needed to realize that short-term investments — say with periods of one to three years — are at risk of losing their principal. After all, in a few days, the stock market can easily lose 10% or more!
So what do you do if you want to save up for shorter periods with higher rates of return than a traditional savings account? Say to put a down payment on a house or buy a new car?
The good news is that with interest rates increasing, there are more opportunities to snag higher returns from short-term investments — while also minimizing risks. In fact, according to the Federal Reserve, it looks like there will be two more interest rates hikes this year and three for 2019.
OK then, so what are the best short-term investments to consider? Here’s a look at five:
5 Best Short-Term Investments: Debt Payoff
Credit card debt can be onerous, with annual percentage rates (APRs) that can exceed 20%. You also are likely required to pay minimum fees of 1% to 2% of your balance. Even worse, the interest compounds — which continues to increase the balance at a hefty rate. Yes, credit card debt can sink you in a financial hole.
In 2018, Americans’ revolving debt hit $1 trillion dollars for the first time since the Great Recession. The average U.S. adult with a credit card carries $5839 in credit card debt.
In light of this, one of your best short-term investments is … to start paying your credit card debt off! You will not only lower our ongoing payments but also improve your credit rating.
One interesting strategy is to transfer your balance to an 0% APR credit card. Usually for a year, there will be no interest as you start to pay down your debt.
Or you can look at debt consolation. This is usually in the form of a personal loan that will have a lower interest rate and after a period of time, you will have paid off your debt.
Best Short-Term Investments: High-yield Savings Accounts
When it comes to risk versus return, high-yield savings accounts offer a nice balance. Keep in mind that you can get an annual return of 1.9% or so. And these accounts are offered by rock-solid financial institutions like American Express (NYSE:AXP), Synchrony Financial (NYSE:SYF) and Goldman Sachs (NYSE:GS), which owns Marcus.com.
A high-yield savings account does not have any restrictions on how long you need keep the money with the institution. You also get full FDIC protection. That is, if the financial institution fails, you are covered up to $250,000 per person.
Then what are the drawbacks? Well, you may not have benefits like ATM access. There may also be large minimum deposit requirements and limits on the number of withdrawals per month.
Best Short-Term Investments: Certificate of Deposit (CD)
If you are willing to lock in your money for a fixed period of time, a certificate of deposit (CD) can provide you with a relatively higher rate. For example, you can get over 3% on a 3-year CD.
You can visit your local bank for this type of investment. But the market is massive. So it’s a good idea to shop around. Keep in mind you’ll get FDIC protection on the investment (again, up to $250,000 per person).
Keep in mind that if you happen to need access to the money in a CD before maturity, then you will have to pay a penalty.
But one strategy to guard against this is to use laddered maturities. For this, you can split up your money between maturities — say between 1 year to 3 years. This means you can gain access to money penalty-free if you need to. What’s more, as a CD matures, you might have the opportunity to reinvest in one that is has a higher yield.
Best Short-Term Investments: Short Term Bond Funds
Short-term bonds can provide higher returns. But these securities can be difficult to analyze. The transaction amounts can also be high.
This is why a short-term bond fund is a good option for short-term investors. You get the benefits of portfolio mangers who can do the research. But you’ll also get the economies of scale of a large pool of assets.
However, it’s a good idea to look for a fund that has low fees. Often what separates the winners from the losers is the cost structure.
In light of this, some short-term bond funds to consider include:
- Vanguard Short-Term Investment-Grade Fund Investor Shares (MUTF:VFSTX): This fund has a minimum of $3,000 and the expense ratio is 0.20%. As for the current yield, it is 3.12%.
- iShares Barclays 1-3 Year Treasry Bnd Fd (NASDAQ:SHY): This is an exchange-traded fund that has an expense ratio of 0.15%. The yield is also 2.50%.
Best Short-Term Investments: Peer-To-Peer Lending
Peer-to-peer lending is an emerging category in the investment world. Through platforms like LendingClub and Prosper, you can lend money to other people — with a term that can be for up to a few years.
The key advantage? Well, you can usually get much higher rates, say above 5% (you are paid interest and principal on a monthly basis). The loan amounts are usually at low amounts (such as $25). This means you can easily diversify your portfolio.
Despite this, the risks can still be difficult to gauge. Peer-to-peer lenders have not been tested during economic downturns. So if you are considering this type of investment, it’s probably best to have it represent only a portion of your total investment.
Tom Taulli is the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.