Certainly, keeping cash in a checking account is both liquid and safe. There’s the added benefit of federal deposit insurance, and it allows easy access to your money whenever you need it with the assurance it’s protected.
However, the downside is that it’s not earning any interest. Given a long-term average inflation rate of around 2%, simply leaving your cash in a checking account can actually diminish its purchasing power over time.
If you’re looking to meet a short-term savings goal, it’s wise to consider investment options that can generate income while still preserving your principal.
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Typically, these options fall within the realm of short-term fixed-income securities. These are financial instruments characterized by their short durations, high credit quality and liquid markets.
“These products are best suited for investors who are saving for a large expenditure (e.g., a down payment, college tuition or a major purchase) with a time horizon of roughly one to three years,” says John Croke, head of active fixed-income product management at Vanguard.
Here are five of the best types of short-term investments for generating income, according to experts:
— High-yield savings accounts.
— Money market funds.
— Certificates of deposit.
— Treasury bills.
— Ultra-short-term bond ETFs.
High-Yield Savings Accounts
One of the simplest ways to enhance the return on your short-term cash is by transferring them from a checking account to a high-yield savings account (HYSA). The trade-off for moving your funds is minor: You might lose conveniences like ATM access and check writing, but in return, you’ll benefit from significantly higher annual percentage yields (APY).
What’s more, your money remains liquid and secure in an HYSA, similar to checking accounts. It’s protected by insurance from either the Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Administration (NCUA), ensuring coverage up to $250,000 per depositor, even in the event that your bank or credit union fails.
When choosing an HYSA, it’s crucial to shop around. Look for accounts offering competitive promotional APYs, but be vigilant about the details. Check for any minimum balance requirements, monthly maintenance fees or expiration dates on promotional rates that could affect your savings potential.
Money Market Funds
“The most significant short-term income opportunity for most investors is to move money from their zero-interest bank accounts and into a money market fund that pays a market rate of return,” says James Dowd, CEO at North Capital. “This is an easy sell once people understand what a money market fund actually is and how it works.”
Money market funds are a type of special mutual fund designed with a fixed net asset value (NAV) per share of $1, aiming to maintain a stable price unaffected by market fluctuations. They primarily invest in high-quality, short-term debt instruments.
Depending on the specific type of fund, these investments can include commercial paper, Treasury bills (T-bills) and repurchase agreements, all characterized by three traits: high liquidity, strong credit quality and short maturities.
When evaluating money market funds, consider the expense ratios, as lower expenses can lead to higher seven-day SEC yields, a measure of the fund’s income-generating potential. It’s also beneficial to choose funds without restrictive minimum investment requirements.
For example, the North Capital Treasury Money Market Fund (ticker: NCGXX) fits this bill perfectly. Despite being an institutional class fund, NCGXX does not require a minimum investment. In addition, by waiving its fee to 0%, the fund is able to pay a very competitive 5.2% seven-day SEC yield.
However, it’s important to understand that while money market funds are considered safe investments, they are not risk-free. In extreme financial conditions, such as during the 2008 financial crisis, there is a remote possibility they could “break the buck,” meaning their NAV could drop below $1 per share.
Certificates of Deposit
While HYSAs and money market funds offer the main advantage of liquidity — allowing you to cash out when needed — they also have their limitations. HYSA rates may not always be the most competitive, and money market funds lack insurance. Moreover, their yields tend to decrease along with falling interest rates.
An alternative for securing higher yields is to invest in certificates of deposit (CDs).
“CDs are time deposits offered by banks with a fixed term, typically ranging from a few months to several years,” explains Taylor Kovar, CEO and founder at 11 Financial. “They provide a guaranteed interest rate, making them a safe and predictable investment.”
For example, if you purchase a one-year CD with an APY of 4.5% and the Federal Reserve cuts rates further during that period, you still receive the agreed-upon 4.5%, maintaining your income potential regardless of market fluctuations. Once it matures, you’ll be paid back your principal.
However, the main drawback of CDs is their reduced liquidity. “The trade-off with CDs is that your money is locked in for the term of the CD,” Kovar notes. “They’re ideal for investors looking for a low-risk option and have a specific time horizon in mind.” Early withdrawal from a CD might result in penalties, typically costing you a portion of the interest that could have been earned.
As with HYSAs, it’s prudent to shop around for the best CD rates. Keep an eye out for promotions and compare the terms offered by different institutions to ensure you are getting the most favorable deal possible.
Treasury Bills
For those looking to generate income from a highly secure source, consider lending to one of the most creditworthy entities on the planet — the U.S. government. This can be done through the purchase of T-bills, which are short-term debt obligations issued by the government.
T-bills are unique in that they are sold at a discount to their face value and have terms ranging from a few days up to 52 weeks. When these bills mature, the government pays you the full face value. The difference between the purchase price and the face value represents the yield, or the profit you earn from the investment.
There are several reasons to consider buying T-bills. They are virtually risk-free, backed by the full faith and credit of the U.S. Treasury Department , making them one of the safest investment options available. Additionally, they offer tax advantages, as the interest earned is exempt from state and local taxes, enhancing their appeal to those in higher tax brackets.
For ease of investment, you can purchase T-bills directly from the U.S. government via TreasuryDirect.gov. Alternatively, if you prefer a more hands-off approach or desire the flexibility of being able to trade your investment like a stock, you might opt to invest through an exchange-traded fund (ETF) that includes T-bills. This method provides the added benefits of liquidity and regular monthly distributions.
“For example, the Invesco Short Term Treasury ETF (TBLL) holds a portfolio of U.S. Treasury securities with less than 12 months to maturity and can provide investors access to T-bills in a single ticker, without having to continually roll positions across multiple accounts as proceeds come due,” says Brian McMullen, senior fixed-income ETF strategist at Invesco.
Ultra-Short-Term Bond ETFs
Among the options listed here, ultra-short-term bond ETFs represent the riskiest choice. These ETFs serve as a more modern alternative to traditional money market funds, catering to investors looking for slightly higher yields without significantly extending maturity.
“Short-term bond 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.
Like money market funds, ultra-short-term bond ETFs typically invest in asset-backed, government and investment-grade corporate securities. These instruments boast high credit quality and short maturities, and the ETFs usually distribute interest monthly.
For an example, consider the Invesco Ultra Short Duration ETF (GSY), which currently pays a 5.1% 30-day SEC yield while charging a 0.23% expense ratio.
“GSY can invest in traditional money market securities like T-bills, commercial paper and repurchase agreements, but can also diversify in other segments of the fixed income market, such as investment-grade corporate bonds, agency mortgage-backed securities and AAA-rated, collateralized loan obligations,” McMullen says.
However, unlike money market funds whose NAV per share is designed to remain constant at $1, ultra-short-term bond ETFs trade like stocks throughout the day, with fluctuating bid and ask prices. This means their price, while generally exhibiting low volatility, is not fixed.
This structure presents a trade-off: You sacrifice some stability for greater flexibility. Ultra-short-term bond ETFs are best suited for investors seeking an approachable blend of traditional bond investing, with the liquidity and ease of trading found in the stock market.
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5 Best Short-Term Investments for Generating Income originally appeared on usnews.com
Update 10/04/24: This story was previously published at an earlier date and has been updated with new information.
