The stock market is a great place to invest for those with long-term plans for their retirement portfolios, but what about investors with more short-term objectives? For these investors, ensuring safety of principal and some income potential tends to be more important than all-out growth.
This is where short-term investments can play an important role. These instruments come in a variety of different asset classes, but they all tend to share some similarities: minimal market risk, lower interest rate risk and the potential for some income generation.
As John Croke, head of active fixed-income product management at Vanguard, puts it: “These products are best suited for investors who are saving for a large expenditure (e.g., a down payment, college tuition, major purchase, etc.) with a time horizon of roughly one to three years.”
“Short-term funds can also be a logical ‘first step’ back into bonds for investors who may have abandoned a traditional fixed income strategy amidst the losses of 2022,” Croke says. “For those who remain nervous about further potential interest rate increases not already anticipated by the market, a short-term fund may be a good starting point,” he says.
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With that in mind, here’s what other experts recommend as some of the best short-term investments for generating income:
— Treasury bill ladder.
— High-yield savings accounts.
— Certificates of deposit.
— Series I savings bonds.
— Peer-to-peer lending.
Treasury Bill Ladder
Anessa Custovic, chief investment officer at Cardinal Retirement Planning, recommends Treasury bills, or “T-bills.” These are short-term bonds issued by the U.S. federal government with maturities of one year or less. T-bills are considered virtually “risk-free” in terms of default and have low interest rate sensitivity.
Custovic particularly likes the four-, eight- and 13-week T-bills. “The rates are very attractive right now and you are not locking up your money for a significant amount of time,” she says. To better plan cash flows, Custovic recommends building a “ladder” of different staggered maturities.
“For example, suppose an investor has $30,000 to construct a ladder. This investor could invest $10,000 in three-year Treasury notes, $10,000 in 52-week T-bills, and $10,000 into 13-week T-bills. As each one matures, the investor gets guaranteed cash flows to reinvest or spend as they see fit,” Custovic says.
High-Yield Savings Accounts
Investors desiring greater flexibility and liquidity when it comes to their investment can use more traditional bank offerings like a high-yield savings account, or HYSA. HYSAs are as safe as it gets, as they’re insured by the Federal Deposit Insurance Corporation, or FDIC, for up to $250,000 per account.
Thanks to rising interest rates, HYSAs are now paying more competitive interest rates, which is expressed as the account’s annual percentage yield, or APY. Investors willing to shop around can find competitive rates from some banks with additional perks like no monthly fees or minimum balance requirements.
Austin Delery, wealth advisor and partner at The Olivier Group, LLC, notes that many local and online-only banks are paying as much as 4% interest on HYSAs with few restrictions. “At the end of the day, the most critical characteristic of a short-term investment is flexibility to cash out,” he says.
Certificates of Deposit
Short-term investors willing to commit to a lock-up period can target higher yields than a HYSA by investing in a certificate of deposit, or CD. By investing in a CD, investors receive interest on their investment, but cannot withdraw their principal investment before it matures.
Allen Mueller, director of financial planning at 7 Saturdays Financial, notes that CDs are currently making a comeback due to higher interest rates. “Depending on the bank, rates for a 12-month CD can be as high as 4.6% right now,” he says. Investors who commit to a longer term can earn even higher rates.
Mueller also likes CDs for the sense of safety. “There is no risk of principal loss, but if you redeem early, you’ll pay a penalty which varies by institution,” he says. Therefore, they’re not the best for investors who need flexibility. Like HYSAs, CDs are also FDIC insured for up to $250,000 per depositor account.
Series I Savings Bonds
As inflation crept steadily upward throughout 2022, one of the more desirable investments was the Series I savings bond, also known as I-bonds. These special government bonds pay a variable interest rate that changes with inflation, which is set twice a year for a six-month period.
Currently, the rate for I-bonds issued Nov. 1, 2022, to April 30, 2023, is 6.89%. Because these bonds are issued by the federal government, there’s virtually no risk of principal loss. However, investors are limited to a $10,000 purchase per year electronically and an additional $5,000 with a tax refund.
However, there are some caveats to watch for. Firstly, I bonds cannot be redeemed in the first 12 months after purchase. In addition, if I-bonds are cashed in before five years, an investor loses the last three months worth of interest payments. Finally, the rate paid will fall if inflation abates.
Peer-to-Peer Lending
Investors willing to venture outside the usual top short-term investments can consider higher-risk alternatives like peer-to-peer, or P2P, lending platforms. These services connect retail investors willing to lend money with other individuals or small businesses trying to borrow it.
By loaning money on a P2P lending platform, an investor receives periodic interest payments on their loan, which is usually higher than those on traditional short-term investments. However, the risk of default is also greater, so there’s no free lunch.
“Investing in P2P lending can help diversify your investment portfolio, as it involves a different asset class than stocks or bonds,” says Levon Galstyan, certified public accountant at Oak View Law Group. “P2P lending also offers flexibility, as you can choose which loans to invest in and how much to invest.”
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5 Best Short-Term Investments for Generating Income originally appeared on usnews.com
