Short-Term Investing and Performance

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When you hear an adviser recommend a "short-term" investment or you read a financial news article about being a short-term investor, what does that mean? How long is short-term and how does one go about investing for the short term?

Putting your money into short-term investments can become part of a strategy that helps you take advantage of rising interest rates over time, but you could also find your funds locked into a fixed return that's lower than the current market, depending on how fast rates are changing. Before you invest, it's important to have some clarity on what qualifies as short-term investing.

Definition of Short-Term Investing

Short-term, with regard to investing, generally refers to a period of less than three years. This is also generally true for categorizing investors as well as bond securities. In fact, many investment securities, including stocks, mutual funds, and some bonds and bond mutual funds, are not suitable for investment periods less than three years. This is because the majority of investors are of the long-term variety, which is to say they are investing for financial goals, such as retirement, that have time horizons that span several years or even decades.

For example, if an investment adviser asks questions to gauge your risk tolerance, they are seeking to determine what investment types are suitable for you and your investment objectives. Therefore, if you tell the adviser your investment objective is to save for a vacation you are planning to take two years from now, you would be categorized as a short-term investor. Therefore short-term investment types would be ideal for this savings goal.

Bonds and bond funds are categorized as short-term if the respective maturity (or more accurately what is called duration) is between one and three and one-half years.

Short-Term Performance In Investment Analysis and Research

When researching and analyzing investments, especially actively-managed mutual funds, a one-year period does not provide any reliable insight into a particular fund's prospects for performing well in the future. This is because 1-year periods do not reveal enough information about a fund manager's ability to manage an investment portfolio through a full market cycle, which includes recessionary periods as well as growth and it includes a bull market and bear market.

A full market cycle is usually three to five years. This is why it is important to analyze performance for the three-year, five-year and 10-year returns of a mutual fund. You want to know how the fund did through both the ups and the downs of the market. Therefore, the short-term (less than three years) is not a consideration when researching mutual funds for long-term investing.

Exploring Short-Term Investments

If you have an investment or savings objective with a time horizon of fewer than three years, appropriate investment types include money market funds, Certificates of Deposit (CD), and short-term bonds. Long-term investment vehicles, such as stocks and stock mutual funds, carry too much market risk for short-term investment objectives. For example, if you believe you may need your money within the next three years, investing in stock mutual funds is too risky because a prolonged period of declining prices, also known as a bear market, can cause the investor to end up with less principal than they invested.

Where to Invest for the Short Term

Once you've decided that you want to invest your money into a vehicle that earns more interest in the short term than your regular savings account, but also offers stability, you have a few good options available.

High-yield savings: The typical interest rate on a savings account is less than one percent. You can find rates that are significantly higher than one percent, by choosing to go with an online bank. These institutions take the money they're not spending on brick-and-mortar locations so that they can pay their customers higher interest rates. You might also find a good high-yield savings account at your credit union. While you'll have easy access to your funds with the high-yield savings option, you'll still earn less than two percent.

Certificates of deposit (CD): You can find CDs in term lengths of three months and up to five years, and you'll get a higher interest rate the longer you're willing to lock up your funds. You'll get a higher interest rate than high-yield savings and enjoy FDIC protection on your money, but you'll be charged a penalty if you need to take the money out before the CD matures.

Money market account: These FDIC-insured accounts let you protect your money while investing it and earning a bit more than the rate on a savings account. It's important to understand the difference between a money market deposit account and a money market mutual fund, though, because the mutual fund version isn't insured by the FDIC.

With a money market account, you'll be able to write checks and may also have a debit card, but you'll likely be limited to a small number of transactions each month. The account pays slightly less than inflation, so consider this when deciding how long to keep your money in this type of account. Additionally, money market deposit accounts usually have a minimum required deposit, so you may need to consider other options if your funds are more modest.

Bond fund: The short-term investment that will pay you more money than all of the above options is a short-term bond fund. Short-term in this case, though, is typically longer than 18 months, but still less than five years.

The returns are slightly less stable, and you won't have FDIC protection on your money. While they offer a higher return potential, you will need to meet a minimum investment requirement.

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.