Given current market valuations and the pending interest rate movement, many investors are drawn to short-term investments. Fortunately for those looking to invest for the short-term, there are multiple options available for short-term investing:
- Treasury Bills
- Short-Term Bond Funds
- Money Market funds
- Savings Accounts
- Short-Term Certificates of Deposits (CD)
Before choosing one or more of the above, consider the pros and cons of short-term investments.
Pros of Short-Term Investments
Short-term investments have two distinct advantages over investments with longer time horizons.
[subtitle3]1. High Liquidity[/subtitle3]
Short-term investments offer high liquidity. Your bank’s savings account offers the greatest liquidity. With an ATM on every street corner, you can withdraw cash from a savings account at a moment’s notice.
Liquidity means money when you want it – to go shopping!
Similarly, Treasury bills can be immediately traded for their fair market value (FMV). However, this trading is limited to hours of market operation. Negligibly less liquid are Money Market and Bond Mutual funds. Relative to a savings account, mutual funds may require a business day or more to settle. This means a waiting period is put between you and your money.
[subtitle3]2. Low Volatility/Risk[/subtitle3]
Savings and money market accounts display minimal volatility. Cash deposits held in bank accounts are insured by the Federal government – up to certain limits. This means that there is less risk of loss to your investment. (However, your money is still subject to purchasing-power risk.) Like a savings account, a certificate of deposit (CD) is stable in value. The exception is when investors forfeit a portion of interest earned for prematurely breaking the CD.
However, short-term bonds and bond funds are subject to fluctuations in value – albeit small changes. Despite this risk, a Wall Street Journal article notes that more advisors are moving their clients’ funds into short-term bond
Cons of Short-Term Investments
[subtitle3]1. Low Return[/subtitle3]
There is no such thing as a free lunch; in exchange for high liquidity and low volatility, short-term investments offer little in the way of investment return. In fact, most commercial banks offer practically nothing on savings accounts right now. Investment custodians (Charles Schwab, Vanguard, etc.) similarly offer negligible returns money market accounts as well.
The return you can expect for every $100 invested in a savings account today.
This is problematic because when your investments generate a low-return, you run the risk of running out of money in retirement.
[subtitle3]2. Tax Treatment[/subtitle3]
Most bond coupon payments and any interest payments are taxed at your marginal tax rate. (Certain municipal bonds are the exception.) This tax treatment is disadvantageous relative to the preferential tax treatment on certain dividends from domestic corporations, as well as the capital gains on long-term holdings.
Knowing both the advantages and disadvantages of short-term investing can help you decide how much of your assets you will invest for the short-term.
Coleman, M. (2013, Nov 15). Short-Term Bonds Gain Traction with Advisers. Retrieved from The Wall Street Journal: http://online.wsj.com/news/articles/SB10001424052702304243904579199782499905484