Short-Term Investments Explained (2023): Beginner's A-Z Guide (2024)

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Planning for the long-term is great for the bigger picture. But what happens when you need to meet a goal in rapid time?

If an investor has a clear goal that is coming up relatively soon, for which he or she will need cash on hand, then long-term investments are a non-starter. But as you might have already heard, just putting your savings away will only lead to one thing – inflation will eat up your hard-earned wealth.

If that is the case, the best thing to do is to choose a third option – investing in the short term. This approach allows investors to preserve wealth, achieve decent returns, all the while maintaining a degree of liquidity.

This approach focuses on securities and assets that you might not have considered investing in before. They won’t offer the stellar returns that high-growth tech stocks or good index funds can, but they fill a certain niche that other assets don’t. Because of these significant differences, short-term investing isn’t something that should be attempted without a clear goal and defined strategy.

In this guide, we’ll go over the topic of short-term investments in meticulous detail – what they are, how they work, what types of short-term investments exist, as well as what strategies and tips a prospective investor should be aware of when investing in the short-term.

What is a Short-Term Investment? 📙

Short-term investments are investments that can easily and quickly be converted back to cash. They are also referred to as temporary investments or marketable securities. Because the goal of short-term investments is to preserve wealth, they are generally low-risk investments, but also offer relatively low returns.

There is no concrete and universal definition of a short-term investment – however, for the purposes of retail investing, anything that you plan on selling or converting to cash within less than three years can be said to squarely fall into this category. Most short-term investments, whether made by retail investors or companies, are solid within a year.

So, why would anyone opt for a less risky but less profitable approach to investing? Well, it’s simple – if there is a large expense coming up in the near future (such as a car, a wedding, or college tuition), then most people will opt for the choice which allows them to convert their investments back into money as soon as possible.

How Do Short-Investments Work? 👷‍♂️

Short-term investments don’t function particularly differently than long-term investments. You invest a certain sum and receive some level of returns. However, the goal of short-term investing is what separates it from long-term investing.

With traditional investing, the goal is to grow one’s wealth – however, with short-term investing, the goal is to preserve it from inflation until one is ready to spend it. Because of this, the line that is drawn between these two approaches is quite clear – and the investments that you’ll pick in either case are very different from one another.

In the case of long-term investing, the most desirable qualities are risk-adjusted returns, growth potential, and various other facets of fundamental analysis. However, in the case of short-term investing, the goal is to find stable, low-risk, and highly-liquid investments.

Types of Short-Term Investments 🗃

The general details of how short-term investments work are quite simple to grasp – but unfortunately, things do start to get a little more complicated from now on out.

To truly understand the topic, it’s important for investors to know what different types of investments are at their disposal. You might be encountering some of these asset classes for the first time – but don’t worry, you’ll come to see that they are actually quite simple to understand once you get into it.

Certificates of Deposit (CDs) 📜

A certificate of deposit is a special type of savings account that offers above-average APY – however, they require investors to set money aside for a certain period of time, usually ranging from three months up to five years. At the end of that term, investors can withdraw their money along with interest.

CDs are considered “safer” investments, compared to stocks and bonds, since they offer a guaranteed rate of return. They do, however, offer a lower opportunity for growth. Should an investor encounter a change of plans or an emergency that would require an earlier withdrawal, they can exit early. But, doing so before the predetermined time passes usually comes with early withdrawal fees.

CDs offer good returns, FDIC insurance, and low transaction fees – the only significant drawback being the early withdrawal penalties. However, with some due diligence and planning, this drawback can mostly be eliminated with the practice of laddering.

Money Market Account (MMA) 💰

Money market accounts (MMAs) are interest-bearing accounts offered by banks and credit unions. Also known as money market deposit accounts (MMDAs), MMAs include features that aren’t typically found in other types of accounts such as higher interest rates, and checkwriting and debit card privileges.

Money market accounts function similarly to the average garden-variety savings account – with two key differences, one of them an advantage, the other a disadvantage. Unlike regular savings accounts, money market accounts offer much better returns on investment – however, in order to achieve this, they require a large minimum deposit.

However, if an investor can afford that minimum deposit, they’ll find that these accounts are worth the price – a lot of them are FDIC insured, and they generally don’t charge anything in the way of fees. Liquidity also won’t be an issue, although investors will typically be subject to a six-withdrawal per statement limit.

Bond Funds🔗

Bond funds provide a simple way to gain exposure to fixed-income securities and diversify at the same time without too much effort. There are a wide variety of bond funds available, so finding the best choice will require a bit of reflection on one’s part – but they are almost certainly going to play a part in an investor’s short-term portfolio.

Bond funds are professionally managed and typically function by laddering or staggering – the fund consists of bonds with varying maturity dates which are continuously replaced as they reach maturity.

Seeing as we’re dealing with the short-term here, it’s important to focus on short-term funds. Investors can opt for U.S. government bond funds, corporate bond funds, or mixed funds that incorporate both types of securities as well as municipal bonds.

Although short-term bond funds offer stability, and the short time horizon means that changes in interest rates won’t affect them much, they do come with minimum investment requirements, and not all of these funds are FDIC insured.

Crypto Savings Accounts 🪙

Now, the mention of cryptocurrency might come as a surprise here. And it’s no wonder – although it is rapidly expanding, the crypto market is still infamously volatile. Crypto savings accounts won’t be a good fit for everyone – but investors with a high risk tolerance should consider them.

A relatively recent development, crypto savings accounts can pay up to 10% and sometimes even 15% APY. On top of that, these accounts usually aren’t associated with any maintenance fees and minimum deposits.

On the other hand, the aforementioned volatility does carry a large degree of risk – and the still undefined regulatory framework that deals with crypto tokens means that these investments are not FDIC insured.

If an investor is already in the crypto market, these savings accounts offer an additional way to earn interest and perhaps reduce some of the risk of their crypto portfolio. For investors who aren’t already in the crypto market, entering it just to open an account like this isn’t worth it.

High-Yield Saving Account📈

A typical checking account pays a miserly interest on the money one puts into it. With checking accounts being a non-starter, the only reasonable alternative when it comes to storing money is a high-yield savings account.

High-yield savings accounts offer much better interest rates, and setting up these accounts is a relatively simple affair. These accounts are offered by banks, as is to be expected, but credit unions are also important players in this area.

There aren’t any big differences between the two – save for the fact that bank accounts are insured by the Federal Deposit Insurance Corporation (FDIC) and credit union accounts are insured by the National Credit Union Administration (NCUA) – although both types of insurance are functionally the same.

High-yield savings accounts are great when it comes to liquidity, although most come with only 6 fee-free transfers per month. When comparing savings accounts, always make sure to read the fine print – account maintenance fees, ATM fees, and inactivity fees can easily make the difference between a stellar account and a horrible one.

As far as cons go, there is only one, albeit significant drawback – this is a stopgap measure that cannot offer long-term protection from inflation. A slight interest rate beats no interest rate at all – but this should under no circ*mstance be a primary method of short-term investing.

Treasurys 🛡

Treasurys is a catch-all term that encompasses treasury bills, bonds and notes. These are securities issued by the United States Federal government in order to issue money – and as such, they are extremely safe, due to the good credit rating of the U.S.

Treasury notes have extremely long maturity dates, so they aren’t the topic of today’s conversation – bills, however, have maturity dates of less than one year, and notes have maturity dates ranging from two to ten years.

Treasurys offer tax benefits, as investors are spared from paying local and state income taxes – although there’s no escaping the dreaded federal income tax. They are backed by a reliable institution, and liquidity is no issue – seeing as how both retail and institutional investors put a lot of faith in these securities.

As far as drawbacks go, treasury instruments generally offer low yields, which is a problem in and of itself, but it also leads to additional problems down the line – one, changing interest rates can make these instruments much less appealing, and two, low yields mean that they are at a bigger risk from inflation than some of the alternatives.

Cash Management Account 🤖

Cash management accounts function almost identically to typical savings accounts – with the key difference being that these accounts are provided by robo-advisors. These accounts combine some of the functions of typical savings accounts and checking accounts into one product, and usually come with extremely low fees.

The cash management accounts offered by top robo advisors come with good interest rates, transparent and welcoming fee schedules, as well as FDIC insurance and simple withdrawal methods. However, the interest rates associated with cash management accounts can’t compete with dedicated high-yield savings accounts.

Series I Savings Bonds 🗓

Series I savings bonds are issued by the department of the treasury and pay interest every month which is compounded every six months. They offer stellar returns as far as bonds go, and even come with tax benefits – although investors will have to pay federal taxes on these bonds, state and local taxes are waived in most cases.

As of early 2022, the interest rate on these bonds is slightly higher than 7%. Between such high returns and the tax benefits, it’s a wonder people even invest in other bonds…right? Unfortunately, wrong – there are a couple of drawbacks associated with these bonds.

For starters, investors can only purchase $10,000 in these bonds per calendar year. On top of that, they aren’t too flexible – investors can cash out only after an entire year has passed, and cashing out before five years have passed comes with a penalty fee that equals three-months interest.

Still, it’s tough to overstate the benefits that these bonds bring to the table – if these fit the desired time horizon, they can prove to be a powerful tool, and are a particularly good fit for laddering.

Pros and Cons of Short-Term Investing ⚖

Now that we’ve covered the basics of how short-term investments work, and how one can go about making such investments, let’s take some time out for a quick summary.

Although short-term investing does have its time and place, it isn’t always the proper move. And even in the circ*mstances where it is the best thing to do, it does have certain objective advantages and disadvantages, which investors should be aware of.

These investments are much less risky and volatile than long-term investments – but the tradeoff is that the returns are likewise lessened. Short-term investments are highly liquid and can easily be turned back into cash for whatever purposes an investor might need.

An investor won’t experience large drawdowns or losses with this approach – but they aren’t in for any pleasant surprises either. On top of that, one might not be as familiar with the asset classes this strategy takes advantage of as with stocks and ETFs – so there may be a need to put in a little time and effort into familiarizing oneself with things like CDs, treasuries, and the money market.

There are a couple of specific approaches to short-term investing that offer above-average gains when compared to conventional short-term investing. We’ll cover them in this guide – but these approaches generally require a lot of experience with certain markets, so most investors will have to make do with limited gains.

On the whole, short-term investing is a sensible approach that beats out the alternatives if a few criteria are met. If you don’t have the time or ability to commit money to long-term investments that last anywhere from three to five or even more years, short-term investing is a way better alternative to just letting inflation eat away at the money you’ve earned.

Short-Term Investing Strategies 👨‍🏫

Up to this point, this guide has mostly dealt with the fundamentals and basics of short-term investing. And while that is all well and good, it isn’t enough on its own to enable one to invest in this way.

Now let’s move on to something a tad bit more concrete – real, actionable tips that investors can put into play, as well as strategies that can be implemented to increase one’s odds of success.

Choosing the Right Trade 🎯

Although short-term investing is much less dependent on timing and external factors than long-term investing, these factors still come into play and should be taken into consideration.

When it comes to external factors, there’s no great mystery – events such as lawsuits, settlements, scandals, bad press, and even regulatory changes and geopolitical events have a tremendous impact on investor sentiment – and investor sentiment, coupled with herd mentality, is the basis of how millions of retail investors will react.

Being aware of these external factors is a soft skill that cannot be mastered all at once – instead, investors should try to incorporate high-quality news sources and financial media into their daily routine. A good first step might be to cultivate a selection of the top investment newsletters which will help keep one up to date on all the latest and most important events.

As for timing, most short-term investment strategies don’t require nearly the same level of timing as approaches like day-trading, swing trading, or scalping do. Be that as it may, buying and selling at the right time can still be the difference between a winning investment and one that eventually tanks.

When it comes to timing, investors should also incorporate elements of technical analysis into their decision-making process. Of course, the fundamentals still matter – but if they find an asset that has promising technical indicators such as moving averages, the odds are much better that a positive trend will hold, which equals a good buying opportunity.

Hedging 🕵️‍♂️

Hedging is a risk-management strategy that requires a bit of a hands-on approach, and comes at a cost – but can serve as a great tool to prevent losses when executed correctly. The chief ingredient of this strategy is derivatives – complex financial instruments that derive their value from the price of an underlying asset.

When an investor uses hedging, they use derivatives such as options, futures, and swaps to protect their investments from any sudden downturns. This can be achieved in a variety of ways, and hedging is an art of its own – but the most straightforward approach is to buy puts at a decent strike price for an asset that is already owned or is going long on.

Diversification 📚

Diversification refers to a risk-management approach that seeks to spread investments out, typically between different asset classes. The reason why this is done is simple – if one part of an investor’s portfolio doesn’t pan out, they won’t suffer nearly as much losses as they would have if all of their investments were tied up in that particular asset class.

Or to put it a bit more colloquially, diversification is the age-old wisdom of “don’t put all your eggs in one basket” applied to investing. Diversification is a very layered and diverse (pun intended) term – there is no one-size-fits-all approach when it comes to properly going about it. The level of diversification that will work in a particular case depends highly on specific circ*mstances.

Be that as it may, there are a couple of good rules of thumb when it comes to diversifying short-term investments. We’ve covered the different types of short-term investments available – it stands to reason that investors should make use of two or three investment avenues rather than just one.

We would also suggest two actionable steps: one, get acquainted with asset class correlations and keep them in mind when making investment decisions, and two, make sure to invest in bond funds – with a mixture of corporate, municipal, and government bonds, all with varying maturity rates, bond funds are a simple and convenient way to diversify that also happens to be relatively hassle-free.

Exhausted Selling 📰

Unlike the strategies that we’ve covered so far, which are general and should always be applied, exhausted selling is a niche approach. It is a day trading strategy that most closely resembles news trading.

Fair warning, however – day trading, even when conducted in the most risk-free way possible, is still inherently a risky approach. It requires a lot of knowledge in the technical analysis department, a good handle on understanding trading psychology, and oftentimes nerves of steel.

Exhausted selling isn’t the most risk-free approach to day trading – in fact, it is one of the riskier ways to go about things. In essence, exhausted selling seeks to take advantage of panic selling – a common occurrence that happens whenever the news cycle starts looking pretty grim.

Just by using early 2022 as an example, we can already see examples of this phenomenon in action, due to the recent war in Ukraine and mounting fears of even higher inflation and recession.

Of course, these events do spell bad news for a lot of businesses – but plenty of companies will either survive unharmed or unscathed or better yet, continue on a positive trajectory. But panic is infectious – once panic selling starts, it tends to spread like wildfire.

Exhausted selling relies on identifying the companies that will “weather the storm” so to speak, buying them at a discount when panic selling occurs, and selling them once the price reaches previous levels, which tends to happen relatively quickly.

It’s tough to pull off, but there’s no denying the appeal of this strategy. However, we should once again point out that it should only be considered by investors that already have a fair bit of experience with day trading.

Real-Time Forex Trading 💱

Real-time forex trading is a rare, slightly unorthodox approach – but when properly executed, it can pay off in a big way. The Forex market by itself is highly liquid but is also considered quite volatile by most investors’ standards. If that liquidity can be utilized while dampening the risks associated with this market, it can serve as a great opportunity for forex trading.

However, the reason why real-time forex trading is rare is that this approach relies on advanced algorithmic trading – a form of investing that requires both years of experience with technical analysis, familiarity with the forex market, and highly sophisticated (and expensive) software to boot. However, most trusted forex brokers support algorithmic trading.

This strategy isn’t a good fit for beginners – for investors who are already familiar with currency trading and technical analysis, investing in the necessary software might be worth the price. Out of all of the strategies we’ve mentioned, this one has the best potential returns by far – but it is also unequivocally the most difficult to execute and riskiest one.

Tips for Short-Term Investing 🌟

Now that we’ve covered the most notable and useful strategies for short-term investing, let’s take a look at some tips and tricks that should be kept in mind no matter what particular strategy one ends up choosing.

Risk Level Determination 📊

Seeing as how short-term investments operate with a shorter time horizon, there isn’t nearly as much time to make up for any potential losses. Experiencing large drawdowns in one’s portfolio is quite normal and is to be expected with long-term investments – after all, there is plenty of time to make up for any potential losses. With short-term investments, that isn’t a risk that should be taken.

Risk is traditionally associated with volatility – therefore, reducing volatility to a level that suits an investor’s goals is the simplest and most straightforward way of managing risk. On top of that, we would argue that investors should focus their investments primarily or completely in the U.S. market – investing in foreign companies is less accessible and subject to market conditions that are much harder to ascertain.

Short-Term Instruments and Synchronization 🎻

While short-term investing encompasses anything with a time horizon of fewer than three years, it’s quite possible and even likely that an investor will have to liquidate his or her assets even earlier.

In most cases, it is a good idea to play it safe and opt for short-term instruments that have a maturation date of less than a year. Short-term bond funds and treasury bills are prime candidates – and if an investor ends up having more time than they anticipated, they can always purchase additional short-term instruments.

When we say synchronization, what we actually mean in plain English is finding investments that mesh well with one’s time frame. If an investor has a planned expenditure coming up, and they know exactly when it will be due (such as 6 months or a year), they should focus on finding investments that have similar maturity dates.

One approach that an investor can consider is laddering their investments. This refers to the practice of choosing instruments with different maturity dates – for example, having 20% of their portfolio in instruments that mature in 3 months, another 20% in instruments that mature in 6 months, and 60% in instruments that mature in a year.

Laddering allows investors to both reduce risk and create a steady, predictable source of liquidity – and as an added bonus, it allows investors to periodically have some cash on hand – which can be rerouted according to changing circ*mstances.

Breakdown: Short-Term Investing vs. Long-Term Investing ⚔

We’re almost done with this guide – so before we leave you with a few parting words, let’s take a step back, absorb everything that we’ve learned about short-term investing, and contrast it with its long-term counterpart.

Most financial media focus on long-term investing – and it isn’t tough to see why. It is the predominant form of investing – it’s a much better approach for retirement planning, growing a nest egg, and even for young people, as they have a lot of time to make up for any temporary losses.

The timeframe of short-term investing is three years at maximum – with most investments being liquidated within a year. Liquidity isn’t an issue, as these assets can easily be bought and sold. In contrast, long-term investing operates on a time horizon of at least three, and preferably at least five years – and while liquidity isn’t guaranteed, due diligence and research go a long way in making sure that liquidity isn’t an issue even in long-term investing.

Most forms of short-term investing take a “fire and forget” approach – once an investor, well, invests, there’s not much else to do. While long-term investing can be done in a passive way as well, by using index funds and ETFs, there is a lot more legwork to be done. As we’ve discussed, there are also some active approaches to short-term investing – but these require previous experience.

Short-term investments are stable and unlikely to experience drawdowns – which is a blessing because if things were different, investors would constantly have to monitor their portfolios. Long-term investments, on the other hand, are much less stable – and while they will most likely experience drawdowns, due diligence and research coupled with the longer timeframe of these investments allow investors to recoup any potential losses.

Conclusion 🏁

That’s it for today’s guide – and thanks for giving us a little of your time to go over this important topic. Short-term investments might not be bombastic and exciting – but they are an important method of wealth preservation.

While short-term investing won’t net awesome returns on its own, knowing the best short-term steps to take with your money is a great way for investors to ensure that they’ll be able to take advantage of all the awesome long-term investment opportunities that will come their way in the future.

At the end of the day, this isn’t a matter of either or. Both of these approaches seek to accomplish different things, and at different times, investors might need to utilize either of these strategies.

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