Looking for the best way to invest money short term? Well, as you can imagine, there is just no “one size fits all” answer. But, depending on how you interpret the following passages, you might come out with a clearer picture by the time you are done reading the whole post.
What is short term to you?
The most important thing we need to get out of the way is to understand your short-term. Generally speaking, in investment terms, short-term is less than a year. But, to some, short-term can mean 1-2 years, 2-3 years or even up to 5 years! You have to decide which one of those categories you fall in.
Less than 1 year?
Money Market Accounts and Savings Accounts (1% Interest)
You probably want to keep your investment as risk free as possible. If you need your investment back in less than a year, you probably want at least the investment amount back and you want it back when you want it back. Think along the lines of an interest bearing savings account or a money market account. Even the best of these accounts will probably only pay you 1% interest. It is not much, yes. But, it is definitely better than stashing your cash in your checking account, where it just won’t grow by even a cent. Besides the guaranteed 1%, you also have the luxury of keeping your investment highly liquid, being able to cash out whenever you want.
If you have a rather large sum to invest, say in excess of $150,000, it might be possible for you to earn interest up to about 1.25% with these two types of accounts. But you will find it extremely difficult to earn anything more than that.
Why so little return you might ask? Well, savings and money market accounts are typically insured by the FDIC (You must not invest if that isn’t the case). When your principal is insured at all costs, you can obviously understand that return is going to be very minimal.
If your short-term investment horizon stretches out to a year, two or even three years, you have a lot more options. Now, please remember that you only have these options if your risk appetite permits it.
If you want to earn anything more than 1%, there is just no guarantee that your principal will return completely. That is just the nature of market risk. Some investment vehicles obviously carry more risk than others. But, the bottom line is that all of the below mentioned investment vehicles carry varying degrees of risk, with a chance that you might not take away what you even brought to the table in the first place.
Bonds are like loans. The Federal and State governments and even local municipal bodies take out loans in the form of bonds. These are government bonds. Corporations also issue bonds when they need money. Yes, it isn’t always private loans or stock issues when they need money. Corporate bonds tend to carry more risk than government bonds as they don’t have a friend in the Federal Treasury to bail them out if things go horribly wrong.
But then, corporations tend to be more profitable than government entities. So, if you buy a government bond, you can be fairly rest assured that your principal might remain with you, with a chance of earning a small decent return of about 1% to about 2% in a great investing environment.
With corporate bonds, you can look to earn as much as 3.29% a year, like how the star performer Vanguard Short-Term Investment-Grade short term bond fund did in the last year. On an average however, you can expect about a 2% return with corporate bonds, with higher assumed risk, as mentioned before.
Low-Risk Stocks and Mutual Funds
Ask Warren Buffett to buy a stock and sell it in less than 5 years and he probably will laugh at the idea. Any investments in stocks or mutual funds need an incubation period of at least 5 years. 10, 20 or even 30 years is much better!
But that being said, it won’t be foolish to invest in a stock or mutual fund for 1 to 3 years either. Stock market returns have averaged out at about 8% a year for a decade now. So, even over 100 years, you can take comfort that equity markets have only grown considerably on average.
The downside however are the crashes, which can be gut-wrenching. 2008 was a year when the Dow Jones fell 33% in one year. Can you imagine taking that kind of a hit to your principal in just a year? In 2013, Dow Jones returned a positive return of 26.5%. Ups and downs.
They will average out if you give the market time. But, with 1-3 years, you run the risk of seeing an extreme negative return that can hurt your short term investment.
While exposure to equity with an investing horizon of just 1-3 years is no doubt risky, you can try to limit that risk by investing in mutual funds or ETFs as opposed to a choice few individual stocks.
Peer to Peer lending
Haven’t heard of peer to peer lending? They can earn you an average return of almost 5% a year! Sites like Proper.com and LendingClub.com allow you to invest your money in a platform that will then loan out money to other individuals in need of money.
What’s special about these sites is that they take credit worthiness into account, meaning that you can hand-pick people whom you lend your money to, according to the strength of their repayment ability. You can view their credit rating (Proprietary scoring used by these sites) and then award as little as $25 towards their loan needs.
Prosper and LendingClub both advocate that investors spread out their investment into several loans, as many as 100, to diversify risk.
It is possible to earn a much higher rate of interest than 5% at these sites but it will require you to loan out your money to individuals with a not so stable credit standing, meaning exposing yourself to more chances of default.
Since you will be able to review a person’s loan request very comprehensively, you can use your acumen and the supporting credit-worthiness data to decide if someone is worthy of receiving your money.
Just like how a mutual fund balances risk, you can balance your investment at these sites by investing 80% in high credit score candidates, 10% in medium credit score candidates and another 10% in low credit score candidates who will have to pay a higher rate of return (but with a higher chance of defaulting).
Repayments made to all your individual component loans will be available for withdrawal or reinvestment as and when they are made. This means that you can constantly fine tune your investment balance to manage risk and return, by reinvesting your proceeds from the ongoing investment.
Medium Risk Stocks and Mutual Funds
A 5 year timeline gives you the cushion to take on more risk. While we won’t say that you can go ahead and invest in small cap stocks, we can say that you can possibly look at large and mid-cap stocks. Maybe have a wee bit of small cap stocks in your portfolio as well. Like a 60% 25% 15% mix.
If choosing mutual funds, don’t just look for mutual funds that boast of a high average return. Look out for expense ratios as well, ratios that are indicative of costs that can eat into your equity returns.
Investing in your own debt!
If you carry expensive personal debt like credit card debt, personal loan debt and also want to make an investment, you might first want to see if using your investment to pay off your costly debt can itself be a great investment.
For example, if you have a credit card that charges you 15% APR and you have a $5,000 balance, you are looking at annual interest charges of $750. Now, you can convert that 15% APR into a 15% return, simply by using $5,000 that you have to pay off your credit card in full, saving handsomely on interest charges. Though you won’t have any incoming cash transfers from the 15% return that you have effectively earned, there is no denying that you saved $750 in interest costs. Saved money is as good as money made on returns, especially if saving money comes with a guarantee and returns don’t!
Now, this isn’t ideal when you need cash liquidity as paying off your credit card means that all your cash will be gone. But then, the chance to earn what is called an opportunity return is a pretty significant one, one that you must consider!
Even if you don’t use your whole short term investment amount to pay off high interest debt, try to use at least a part of it to pare down your debt. It is a guaranteed way to earn a return on your money.