Best Mutual Funds for Short-Term Investing

How to Choose the Best Mutual Funds to Invest for the Short Term

short term investing
••• Learn the best ways to invest for short-term financial goals. Getty Images

Choosing the best mutual funds for short-term investing needs can be more challenging, and potentially more risky, that investing for long-term investing needs, such as retirement.

Most investors have more short-term savings goals and financial needs than they do long-term investing goals. Some of the general reasons for investing in the short term include earning better interest than traditional banking accounts or trying to achieve returns that can keep up with inflation. Specific short-term goals may include emergency funds, vacations, or down payment for purchasing a vehicle.

What Exactly is Short-Term Investing?

When you read or hear about short-term investing, the terminology is generally referring to investing for periods of less than three years. It is important to keep in mind that many investment securities, including stocks, mutual funds, and some bonds and bond mutual funds, are not suitable for investment periods less than 3 years. For this reason it is important to know and understand which investments are suitable for short-term periods and which are not.

Generally stocks and stock mutual funds are not appropriate for short-term investing, This is because the odds of losing value in that time frame is too great for investors to risk in exchange for higher returns. Most bond funds are appropriate for short-term investing. However, if there is any foreseeable risk of rising interest rates, investors may want to avoid long-term bond funds because of their interest rate sensitivity.

Mutual Funds Suitable for Short-Term Investing

Some investors and savors may prefer money market funds for their liquidity and relative safety but bond funds will generally provide the best yields and returns for short-term periods of one year to three years.

Here are some of those bond fund types to consider for your short-term financial goals:

  • Ultra-Short-Term Bond Funds can be a smart choice for investors wanting yields higher than money market funds but less interest rate risk than bond funds with longer durations. In some environments, such as periods of rising interest rates, it is possible that ultra-short-term bond funds will not outperform money market funds. Therefore the investor will need to choose carefully between the two. Generally, ultra-short-term bond funds can produce average annualized returns of 2% to 3%, especially over periods of more two or more years.
  • Short-term Bond funds primarily invest in bonds that have maturities of less than 4 years. Conservative investors tend to like short-term bond funds because they have lower interest rate sensitivity. However, short-term bond funds have lower relative average returns over time than intermediate and long-term bond funds. A reasonable average rate of return to expect over a three-year period is around 3% to 4% for short-term bond funds. This rate of return is sufficient to match the rate of inflation.
  • Intermediate-term Bond funds primarily invest in bonds that have maturities averaging between four and 10 years, although these bond funds are still appropriate for periods less than three years These bond funds offer a combination of reasonable returns, averaging around 5%. However, keep in mind that the interest rate risk is higher for intermediate-term bond funds than those with shorter durations. Therefore, if interest rates are expected to rise in the near future (and during the projected investment time horizon), investors may want to avoid intermediate-term bond funds.

    As a final word on short-term saving and investing, investors should remember that risk tolerance plays a role here, just as in investing for longer periods. For example, if an investor is not comfortable with a chance of losing principal over the investing/saving period, it may be more suitable for that investor to use safer, more liquid vehicles, such as money market funds, certificates of deposit, or bank savings accounts for their needs.

    Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.