Time and time again, you’ve been told about the importance of investing for your future. Tucking money away while you’re young can make things much easier for you in retirement.
But what if you have goals with shorter time horizons? For example, you may want to buy a house within the next three years or open that bakery you always talked about with friends. What then?
Investment options that work for retirement savings, such as individual retirement accounts and aggressive stock portfolios, may not be good choices for short-term goals since there’s a higher chance you could lose money. When you have a short period of time to invest, more conservative investment options may offer a better solution.
When you’re investing for long-term goals, many experts recommend a more aggressive approach to investing that takes into account your risk tolerance, time horizon, and investment objective. Your investment portfolio will likely be made up of mostly stocks, and to make your money work as hard as possible, you could utilize tax-advantaged investment accounts like individual retirement accounts (IRAs) or 401(k) plans.
IRA: With a traditional IRA, you may be able to deduct the contributions you make to the account from your taxable income, and you can enjoy tax-deferred growth.
401(k): With a 401k, you make contributions with pre-tax dollars and your earnings can grow tax-deferred.
Because of those tax benefits, the government implemented restrictions on how money in these accounts can be used. If you withdraw money from the accounts, you may have to pay penalties depending on your age or other factors, on top of income taxes. So when you need to access money within a short period of time, you’ll need to consider short-term investments and other account options.
Generally, short-term investments are much more conservative. Since you’ll need the money within a few years, it can be more risky to invest in stocks with less time to weather market fluctuations. The goal with short-term investments is modest growth while seeking to protect your investment.
If you need to access cash relatively soon, tax-advantaged accounts can be less accessible or incur penalties when withdrawn from early. Instead, you may want to consider bank deposit accounts or other options that aren’t as restrictive.
While these can vary by investment type, there are typically three main advantages to short-term investing:
Long-term investments can be limited by when and how you can use the money you stashed away. But with short-term investments, you often have more flexibility, and you can typically withdraw money sooner.
The stock market has the potential for growth, but there is also the risk of severe losses. Short-term investments often aim to limit your level of risk while providing some limited returns.
Many short-term investment options tend to be simple, with relatively low levels of risk. You don’t need to hire a financial advisor or investment professional to manage your investments for you. These types of investments can be handled by even novice investors.
Although many short-term investments carry less risk, there are some potential downsides:
The stock market’s average annual returns are 8% to 10%. But because the market can change so much, you may not be able to take the risk of investing solely in stocks for short-term goals. Instead, you have the option to invest in more conservative securities with lower returns.
Accounts for short-term investing rarely have the tax benefits of accounts focused long-term goals, such as retirement. As a result, you might have less flexibility in tax payment and planning.
When you need to set aside money for the short-term, you’ll likely be focused on ways to protect your funds, but also earn returns to help your money grow faster. Some short-term investments include:
If you have money in a savings account, you may be discouraged by how little interest your money is earning. Nationally, the average annual percentage yield (APY) is just 0.33%. But if you transfer your money to a high-yield savings account, you can get higher interest rates and still be able to access your funds when you need them. As of February 2023, there are rates as high as 3.75%.
Moving your money to a high-yield savings account can be the least risky option for those looking to earn a steady return on their cash.
You can find high-yield savings accounts with many banks, credit unions, and brokerage platforms. As you research available accounts, make sure the financial institution is backed by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). FDIC-insured or NCUA-insured accounts will have your funds protected up to $250,000 in the event of bankruptcy.
A treasury note, also known as a T-note, is a debt security issued by the U.S. government. It has a fixed interest rate, and you can choose a maturity date of between two and 10 years. The government pays interest on the notes every six months until they reach their maturity date.
You can purchase a Treasury note with as little as $100, and your rate of interest is dependent on the maturity term and date of purchase. As of the end of January — the last available data — Treasury notes with two-year terms had rates as high as 4.373%.
You can purchase Treasury notes through a TreasuryDirect account or through a bank, broker, or dealer.
Like Treasury notes, Treasury inflation protected securities (TIPS) are short-term investments issued by the U.S. government. TIPS were designed to provide investors with some protection against inflation. They have a fixed interest rate that is set at auction, and their principal value is adjusted every year to account for inflation changes.
TIPS pay interest every six months until it matures or is sold. You can choose a maturity term of 5 years or longer, so they may not be a good fit for those seeking immediate gains. Visit TreasuryDirect to learn about TIPS or to purchase them online.
When companies need to raise capital for major projects or to expand their operations, they may sell corporate bonds to investors. Corporate bonds function like a loan — by buying a bond, you’re lending the company money. In exchange, the company agrees to pay you a set rate of interest along with the bond’s principal when it reaches its maturity date. Short-term corporate bonds can have terms of three years or less.
While corporate bonds are usually less risky than stocks, there is some level of risk to keep in mind. The corporate bond is completely dependent on the company’s ability to repay it. If the company fails or goes out of business, it could default on the bond.
You can purchase short-term bonds from brokers or dealers.
Municipal bonds are issued by states, cities, or counties to finance public projects like road construction or school development. They can be appealing investment options because they have relatively low default risks compared to corporate bonds, and the interest income you earn is typically exempt from federal income taxes.
Like corporate bonds, municipal bonds can be purchased through brokers and dealers.
Money market accounts are a type of deposit account that some banks and credit unions offer to their customers. In general, money market accounts offer higher APYs than savings accounts, so you could get a higher return. But they also usually require a higher minimum deposit. You are limited to six withdrawals or less per month, and you often have to maintain a minimum balance.
CDs are a popular short-term investment because they are a risk-free way to earn a higher return. They are offered by banks and credit unions, and are excellent tools to save for shorter-term goals.
With a CD, you commit to keeping your money in the CD for a specified term. Terms can range from three months to 10 years, and during that term, you’ll earn a fixed rate of interest. Once the CD’s term ends, you get the principal and the interest you earned.
The downside? If you have an emergency and want to tap into the CD before its term date, you’ll have to pay hefty penalties.
With an ETF, you pool your money with other investors to create a fund that invests in stocks, bonds and other securities. ETFs are traded on the major national stock exchanges, such as the New York Stock Exchange or Nasdaq, and they allow you to invest in hundreds of companies or securities at once.
ETFs are a way to easily diversify your portfolio. And if you have a short time frame to meet your goals, you can opt for conservative ETFs that invest in treasury or corporate bonds. To invest in ETFs, you need to open a brokerage account.
If you have a financial goal that you want to accomplish within the next few years, such as buying a new car or saving for a down payment on a home, short-term investments could be a better choice because they help you minimize risk while still earning a return.
For other goals, such as your retirement, a long-term approach to investing may be preferable because it can allow you to invest more aggressively. And, you could have the benefit of compounding. Over time, compounding has the potential to help you earn returns on both the original investment and any returns you’ve earned previously, helping your money grow faster.
Try our compound interest calculator to see for yourself!
With Acorns Invest, you can open a brokerage account and invest in expert-built portfolios of ETFs. Acorns will ask you questions about your goals and risk tolerance to recommend a personalized ETF portfolio of stocks and bonds to help you meet those goals.
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