Short-Term Investing and Performance

Putting your money into short-term investments can be part of a plan that will help you take advantage of rising interest rates over time. But you could also find your funds locked into a fixed return that's lower than the current market. It can depend on how fast rates are changing.

You should have some insight on what qualifies as short-term investing before you part with your dollars.

Definition of Short-Term Investing

"Short term" often refers to a holding period of less than three years. Many securities, including stocks, mutual funds, and some bonds and bond mutual funds, are not suitable for periods of less than three years. Most investors have long-term plans. They're saving for goals such as retirement, with horizons spanning many years or even decades.

An adviser who asks questions to gauge your risk tolerance is trying to determine what investment types are right for you and your goals. You would be a short-term investor if you tell your adviser that your goal is to save for a vacation you're planning to take two years from now. Short-term investment types would be ideal for this type of savings goal.

Individual stocks and mutual fund shares don't come with any set maturity or expiration dates. A short-term investment in these assets would mean that you intend to hold and then sell them at some point before the end of a three-year window of time.

You would choose bond issues with a maturity date of three years or less if you purchase bonds directly to hold in your portfolio rather than through a bond fund.

Short-Term Performance in Investment Analysis

One year does not provide any solid insight into a fund's prospects for the future when you're analyzing investments. This is especially the case with actively managed mutual funds. One-year timeframes don't tell you enough about a fund manager's ability to guide a portfolio through a full market cycle. This would include recessionary periods, as well as growth. It would include both a bull market and a bear market.

A full market cycle is often three to five years. Analyzing performance for the three-year, five-year, and 10-year returns of a fund is therefore key. You want to know how the fund did through the market's ups and downs. The short term (less than three years) is not helpful when you're researching mutual funds for long-term goals.

Exploring Short-Term Investments

Appropriate investment types include money market funds, certificates of deposit (CD), bond funds that invest in short-term bonds, and bonds with maturities of three years or less if you have a savings goal of three years or less. Long-term options, such as stocks and stock mutual funds, carry too much market risk for the short term.

Investing in stock mutual funds is too risky if you think you may need your money within three years. Any prolonged period of declining prices can cause you to end up with less principal than the original amount you invested. Declining prices occur during a bear market.

Where to Invest for the Short Term

You have a few good options if you've decided that you want to invest your money in a way that earns more interest in the short term than your regular savings account, but that also offers stability.

High-Yield Savings

The average interest rate on a savings account was 0.06% as of April 19, 2021. You can find rates that are much higher than that if you set up an account with an online bank. These banks can use the money they're not spending on brick-and-mortar buildings to pay their customers higher rates.

Certificates of Deposit (CDs)

You can find CDs in term lengths from three months up to five years. You'll earn a higher interest rate the longer you're willing to lock up your funds. The rate will be higher than that of high-yield savings. And the Federal Deposit Insurance Corporation (FDIC) will protect your money. But you'll be charged a penalty if you take the money out before the CD matures.

Money Market Accounts

Money market accounts are also insured by the FDIC. You can protect your money while investing it. These accounts pay a bit more than the rate on a savings account.

You should be able to write checks with a money market account, and you may also have a debit card. But these accounts are often limited to a small number of transactions each month.

A money market account pays slightly less than inflation. So keep this in mind when you're deciding how long to keep your money there. These accounts also often have a minimum required deposit. You may want to look into other options if your funds are more modest.

Bond Funds

A short-term bond fund is an option that will pay you more money than the other choices. Short term refers to the maturity dates of bonds held inside the fund in this case. The bonds mature from one year to five years. A bond fund's manager buys bonds with staggered maturity dates. They then replace them with new bonds as needed.

You can keep your money in shares of the fund for a full three years or for as short a time as you'd like. Bond funds that invest in securities with short-term maturities often have fewer negative effects from changing interest rates than funds that invest in bonds with longer-term maturity dates.

You can also diversify by buying shares in bond funds that hold a mix of corporate, government, and municipal bonds with varied maturities. This will protect your money during your short-term timeframe.

The trade-off is that bond fund returns are slightly less stable. You won't have FDIC protection on your money. They offer a higher return potential. But you'll have to meet a minimum investment requirement.

Disclaimer: The information on this site is provided for discussion purposes only and should not be taken as investment advice. Under no circumstances does it represent a recommendation to buy or sell securities.