What Are the Best Short-Term Investing Options?

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When you're investing for the long term, such as for retirement, you typically buy stocks and mutual funds designed to help achieve long-range financial goals. A short-term investment, on the other hand, is one that you hold for roughly one to five years and that you can tap if you need quick cash. Goals for a short-term investment might include an emergency fund, a European cruise or a down payment on a house.

Long-term investments often come with more risk in exchange for higher returns over time. By contrast, short-term investments like savings accounts and certificates of deposit (CDs) normally involve lower returns but also lower risk, providing more liquidity. Even though they'll likely deliver less bang for your buck, short-term investments are a smart addition to your financial portfolio, especially if you haven't yet established an emergency fund. Here are some of the best short-term investment options to consider putting alongside your long-term nest egg.

High-Yield Savings Account

As the name suggests, a high-yield savings account provides a higher interest rate than a traditional savings account does. The interest rate on a savings account is expressed as APY, or annual percentage yield. Online banks frequently offer higher APYs than regular banks. Why? Because, unlike online banks, regular banks must cover the costs associated with operating bank branches.

While a high-yield account from an online bank might be more attractive than a lower-yield account from a traditional bank, keep in mind that a higher APY might be offset by minimum deposit amounts and minimum (and possibly maximum) balance requirements.

Remember that an account's APY can fluctuate regularly, based on overall interest rates. As of October 2020, the highest APYs for high-yield savings accounts ranged from 0.80% to 1.10%—that's down from around 2% last year at the same time. However, it handily beats the average standard savings account APY of 0.09%.

This investment option is best if you'll need to access your money within the next one or two years.

  • Risk level: Very low. The Federal Deposit Insurance Corp. (FDIC) insures deposits at member banks up to $250,000, while the National Credit Union Administration (NCUA) insures deposits at all federal credit unions and most state-chartered credit unions up to $250,000.
  • Next step: Shop around for a high-yield savings account with a financial institution whose deposits are insured. Online banks to check out include Ally, Axos, Chime, CIT, Synchrony, Varo and Vio.

Money Market Account

Similar to a high-yield savings account, a money market account often pays a higher APY than a traditional savings account. A money market account also might issue a debit card and let you write checks. This kind of account might, however, impose fees and minimum deposit requirements, and limit the number of transactions allowed per month.

This investment option is best if you might need your money within the next one or two years.

As of October 2020, several financial institutions offered money market accounts with APYs of 0.60% to 0.70%, compared with the average money market APY of 0.11%.

  • Risk level: Very low. The FDIC insures money market account deposits at banks up to $250,000, and the NCUA insures deposits at most credit unions up to $250,000.
  • Next step: You can open a money market account at an online bank, a traditional bank, a credit union or a financial services company. Financial institutions that offer these accounts include BMO Harris, Charles Schwab, CIT, Discover, Sallie Mae and TD Ameritrade.

Certificate of Deposit (CD)

A CD is a savings account that holds a set amount of money for a period of time, such as six months, one year, five years or even 10 years. With a CD, a bank or credit union generally offers a higher APY than it would for a traditional savings account.

When you cash in a CD, you get the money you originally deposited plus the interest you've accumulated. But if you pull out the money before the CD reaches what's known as the maturity date (such as one year from the time you deposited the money), you might be hit with a financial penalty. Many CDs require minimum deposits of $500 or more.

This investment option is best if you might need your money within the next two to five years.

As of October 2020, average APYs for CDs ranged from 0.27% for a one-year CD to 0.43% for a five-year CD. One of the highest rates was 1.5% for a five-year CD.

  • Risk level: Low. The FDIC and NCUA typically insure CDs up to $250,000. However, you risk losing some of your money if you make a CD withdrawal before the maturity date.
  • Next step: Investigate APYs, penalties and minimum deposit requirements for CDs. Banks that offer CDs include Ally, BankDirect, Capital One, CIT, Discover and Synchrony.

Short-Term Bond Fund

Generally, a short-term bond fund invests in an array of bonds that mature in one to three years. Governments and corporations are among those that issue short-term debt in the form of bonds.

Returns on short-term bond funds vary. As of September 2020, investment broker Vanguard listed the average annual return for its short-term bond fund 4.89% over a one-year period and 3.42% over a three-year period.

This investment option is best if you might need your money within the next two to three years.

  • Risk level: Low. Short-term bond funds typically are less risky than stocks but a bit riskier than investment vehicles like savings accounts. They aren't insured by FDIC or any other government agency.
  • Next step: Contact an investment broker if you're interested in exploring short-term bond funds. Among brokers that sell them are Charles Schwab, Fidelity, iShares and Vanguard.
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Money Market Mutual Fund

Money market mutual funds, also called money market funds, invest in highly liquid short-term debts. These types of debt include CDs and U.S. Treasuries. Money market funds are not the same as money market accounts.

Annual returns for these funds typically range from 1% to 3%. A bonus is that money market funds don't charge any fees when your cash goes in or out.

This investment option is best if you might need your money within the next two to three years.

  • Risk level: Low. Money market mutual funds are viewed as less risky than stocks or bonds. They're not insured by the FDIC or NCUA, though.
  • Next step: Take a look at investment brokers that sell money market mutual funds, including Fidelity and Vanguard.