The Federal Reserve raised interest rates in December 2016 for the first time since 2006, but rates are still at historical lows, which is good news for borrowers. If you're buying a new home or car you're in luck: You can take advantage of interest rates that haven't been this low in decades.
If you're a saver or an investor looking for short-term investment options, you haven't been so fortunate, though. Low interest rates make it difficult to grow your cash, so you must choose carefully among short-term investment options and decide which one is right for you.
The term "short-term investments" might be considered an oxymoron by some because investing typically refers to purchasing a financial asset _ like a stock or bond _ with the expectation that it will provide income and appreciate in value over time. Think of a short-term investment as money to grow and compound but will need within two to five years. Here are the best options for investing for the short term.
WHEN DO YOU NEED SHORT-TERM INVESTMENT OPTIONS?
Because long-term investing in the financial markets offers greater returns, you might wonder why an investor would need short-term investments. Consider this scenario: Maybe you're saving money for the down payment on a house you plan to buy in four years. If you put those funds in the stock market in hopes of making money, you could achieve higher returns, but you'll also take on more risk.
Stocks typically return about 10 percent per year over the long term, according to the Financial Industry Regulatory Authority. However, they also carry the most risk. For example, between 2008 and 2009, stock prices dropped 57 percent. If you invested money in stocks that you were planning to use in a year or two and they lost 20 percent of their value in one year, you'd likely be very disappointed.
You can protect yourself from scenarios like this by diversifying your portfolio. One effective way to get a diversified portfolio is to invest in short-term options.
BEST SHORT-TERM INVESTMENT OPTIONS
Here are some short-term investment options that might be a good fit. Examine them carefully and discover which ones best suit your needs and budget.
SAVINGS ACCOUNTS
If you have money in a savings account at a bank or credit union, it's likely insured for up to $250,000 by the FDIC or National Credit Union Share Insurance Fund, making this type of account a very low-risk investment. In addition, savings accounts and money market deposit accounts allow you to withdraw all of your funds at any time without incurring a penalty. These types of accounts usually pay interest, but typically at a lower rate than some other short-term investment options, like certificates of deposit.
You can maximize the interest you earn on your savings by choosing a high-yield savings account. Online banks often offer high-yield savings accounts _ they can do this because they don't have the same overhead costs as traditional brick-and-mortar banks, so they can pass these savings to customers. Wherever you open your savings account, make sure it's insured by the FDIC or NCUSIF.
BROKERAGE MONEY MARKET MUTUAL FUNDS
Although bank and brokerage money market accounts might sound the same, they aren't. A money market mutual fund is a low-risk mutual fund that holds investment-grade, short-term government bonds _ and sometimes triple A-rated corporate debt _ that mature between 30 and 90 days.
Like a typical mutual fund, an MMF sponsor pools investors' savings into a fund typically organized as a trust. However, MMF sponsors are restricted in what kind of investments they can make. In addition, the assets and liabilities involved with these types of funds are determined differently from other mutual funds. If you invest in an MMF, you can redeem your shares on demand and get the price you paid for them, which you can't do with other mutual funds. Some MMFs even allow investors to write checks on these accounts.
Although money market funds traditionally hold their value at a share price of $1, there's no guarantee that the principal value won't deviate from $1, which makes the MMF riskier than the comparable bank and brokerage account products.
Although the Federal Reserve raised interest rates in 2016, some countries are using negative interest rates. This means their central banks _ and perhaps private banks _ charge negative interest, so instead of receiving money on deposits, depositors must pay regularly to keep their money in the bank. If the Federal Reserve drops rates below zero, MMFs could lose money.
CERTIFICATES OF DEPOSIT
A certificate of deposit is a time deposit account _ issued by banks and credit unions _ that works like a promissory note. In exchange for a competitive, fixed interest rate, you're required to keep your money in the account for a specified amount of time.
CD term lengths range from a few months to five or more years. The interest rate depends on how much money you put in the CD and how long a term you choose. Generally speaking, the more money you deposit and the longer the term you choose, the higher your interest rate will be.
However, if you withdraw money from the CD before its maturity date, the withdrawal is subject to a significant penalty fee. In general, you'll get hit with a penalty of three to six months' interest if you take the money out early.
One way to maximize returns on a CD is to ladder it: This means you invest proportionally in a variety of term lengths. Then, as each shorter certificate matures, you reinvest the proceeds in the CD with the longest term. So, if you want to invest $10,000, you might put $2,000 apiece in one-, two-, three-, four- and five-year CDs. At the end of the first year _ when the one-year certificate matures _ you'd put that money into a new, five-year CD. The next year, you reinvest the funds from the matured two-year certificate in another five-year CD.
TREASURY INFLATION-PROTECTED SECURITIES
Treasury Inflation-Protected Securities are marketable securities designed to protect investors from the negative effects of inflation, and their principals adjust according to changes in the consumer price index. TIPS are issued with maturities of five, 10 and 30 years and pay interest twice a year. When inflation picks up, TIPS can shine. In addition, although you'll have to pay the Feds, the interest you earn on TIPS is exempt from state and local income taxes.
You can invest in TIPS with a minimum of $100, and you can purchase additional TIPS in increments of $100. You only need to hold the TIPS for 45 days before you can cash out.
TIPS are considered low-risk investments because they are backed by the U.S. government and because their value rises with inflation but the interest rate remains fixed. However, TIPS usually carry lower interest rates than other corporate and government securities, so they might not be a good choice if you're an income investor.
SERIES I SAVINGS BONDS
A Series I savings bond is an interest-bearing U.S. savings bond designed to protect against inflation. Most Series I bonds are issued electronically, but you can purchase paper certificates with a minimum of $50 using your income tax refund.
This investment has two return components and will earn interest for up to 30 years. The first component is a fixed interest rate set at issue. The second interest rate is based on the inflation rate and usually adjusts twice a year. Series I savings bond interest payments are free from state and local taxes and, in some cases, completely tax-free, such as when you use them to pay for qualified educational expenses.
An I bond, available through TreasuryDirect.gov, can be a great investment for those without a lot of cash because the minimum investment starts at just $25. You're required to hold an I bond for a minimum of one year, so if you're an ultra-short-term saver, this likely is not an option for you.
If you cash in an I bond before five years have passed, you'll sacrifice three months of interest. Also, you're limited to $10,000 in purchases per year but can purchase an additional $5,000 worth of these bonds if you use your tax refund to buy them.
