Investing isn’t a one-size-fits-all proposition; the core principle of investment portfolio construction lies in aligning your financial choices with your unique objectives and time horizon. For example, if you’re investing for retirement and have several decades to go, you’d generally prioritize long-term growth.
This often means allocating a significant portion of your portfolio to higher-risk, higher-reward assets like stocks, which offer the potential for robust returns over the long haul. The longer time frame allows you to weather market volatility and capitalize on the magic of compounding.
However, if your investment goals are more immediate — say, you’re saving for a home down payment within the next few years — the investment landscape shifts. In this scenario, the focus typically moves from capital growth to capital preservation and income generation.
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The risk appetite is generally more conservative because the time frame for recovery from potential losses is much shorter. Instead of swinging for the fences, you’re looking for steady, reliable places to park your money while still achieving modest returns.
The objective is to strike a balance between minimizing risk and earning a return that outpaces inflation, keeping your immediate financial goals within reach. This is where short-term investments can play a role, thanks to a combination of minimal volatility, low interest rate risk, income potential and liquidity.
“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,” says John Croke, head of active fixed-income product management at Vanguard.
Even long-term, buy-and-hold investors can find a place in their portfolio for short-term investments as a way to further dampen volatility and reduce drawdowns. “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.
Here are five of the best types of short-term investments for generating income, according to experts:
1. Treasury bills.
2. Certificates of deposit.
3. Money market funds.
4. Ultra-short-term bond funds.
5. Target-maturity bond ETFs.
1. Treasury Bills
Treasury bills, or T-bills, are short-term debt securities issued by the U.S. government. When investors purchase a T-bill, they’re effectively lending money to the government. In return, the government agrees to pay back the full face value of the bill upon its maturity. A good way to think of them is as an IOU from the government that matures in a year or less — commonly in one month, three months, six months or one year. They represent the short end of the Treasury yield curve.
“On a risk-adjusted basis, we think T-bills are the most attractive short-term investment for income right now,” says Thomas Samuelson, chief investment officer at Vineyard Global Advisors. “The 5.3 to 5.5% yield is very attractive considering its risk-free profile and since it’s non-correlated to both stocks and bonds.” Given their short maturity and U.S. government-backed status, T-bills enjoy both low interest-rate risk and credit risk, making them one of the safest investments out there.
2. Certificates of Deposit
“Certificates of deposit, or CDs, are time deposits offered by banks with a fixed term, typically ranging from a few months to several years,” says Taylor Kovar, CEO and founder at Kovar Wealth Management. “They provide a guaranteed interest rate, making them a safe and predictable investment.” When investors purchase a CD, they lock in a fixed rate of interest for the CD’s term. Even if interest rates change during this time, the interest rate paid by the CD will not fluctuate.
However, these instruments do have a key drawback. “The trade-off is that your money is locked in for the term of the CD,” Kovar says. Investors who cash in a CD before the maturity date may have to pay an early withdrawal penalty. For success with CDs, investors should have a clear idea of when they need to access the money. “They’re ideal for investors looking for a low-risk option and have a specific time horizon in mind,” Kovar says.
3. Money Market Funds
A money market fund is a type of mutual fund that invests in highly liquid, short-term financial instruments like Treasury bills, commercial paper and repurchase agreements. Often used as a cash equivalent to park funds temporarily, money market funds offer liquidity and safety within a brokerage account. The net asset value of a money market fund is structured to remain stable at $1 per share, making it easier for investors to get in and out without losing principal.
“We believe money market funds are currently the best short-term investment to generate income, as these kinds of funds generally invest in very short-term debt that is highly liquid, of higher quality and with less associated risk,” says Emily Cozad, portfolio manager and research analyst, and investment funds specialist at Buckingham Advisors. “Additionally, money market funds aren’t overly complicated for the average investor — making it easier to choose, invest and maintain exposure in the best option.”
[7 Best Money Market Funds to Buy for Safety]
4. Ultra-Short-Term Bond Funds
Ultra-short-term bond funds invest in investment-grade fixed-income securities with very short maturities, typically under a year. These funds aim to provide a higher yield than money market funds while still maintaining a low risk profile. Available in mutual fund and exchange-traded fund, or ETF, form, ultra-short-term bond funds are a middle ground for those who are looking for slightly higher returns than a money market fund but aren’t willing to take on the risks of longer-term bonds.
However, ultra-short-term bonds are by no means risk-free. “While ultra-short-term bond funds generally provide a higher yield than money market funds, they are a bit more unsteady,” Kovar says. Unlike money market funds, the net asset value of an ultra-short-term bond fund is not fixed at $1 and can fluctuate. “However, their short duration means they’re less sensitive to interest rate changes, making them a good choice for a slightly more aggressive short-term investment,” Kovar says.
5. Target-Maturity Bond ETFs
Defined maturity bond ETFs, such as iShares’ iBonds or Invesco’s BulletShares, offer a unique solution for short-term investors who want the benefits of a diversified bond portfolio but also seek the certainty of a maturity date. Unlike most bond ETFs, which hold a continuously changing portfolio to maintain an overall target maturity range, defined maturity bond ETFs contain a portfolio of bonds that are all set to mature within a specific year, all the while paying out monthly interest.
This creates an experience more akin to holding individual bonds that mature and return principal at a set date. When the specified year arrives, the ETF liquidates its holdings and distributes the value to investors, effectively “maturing” much like a regular bond would. “This structure provides clarity on return and yield, making them suitable for investors with a specific time frame in mind,” Kovar says. For example, an investor who needs the money in 2025 can buy a target maturity bond ETF for that date.
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5 Best Short-Term Investments for Generating Income originally appeared on usnews.com
Update 09/19/23: This story was previously published at an earlier date and has been updated with new information.
