munKNEE.com Your Key to Making Money
A Site For Sore Eyes & Inquisitive Minds
If you are saving money for a down payment on a house or [a] car you plan on buying next year and you do not want to risk your money in the stock market…looking for somewhere to invest for the short term [is the way to go and] there are some really good options out there for you…
The original article has been edited here for length (…) and clarity ([ ]) to provide a fast & easy read.
Below is a list of 6 short term investment options for you to consider.
1. Pay Off High Interest Debt
Maybe paying off high interest debt does not first come to mind when thinking about short term investments but it could be the smartest move.
- For example, if you have debt that has an 10% interest rate paying that down would provide you essentially a 10% return on your investment. On top of that, paying down debt is similar to achieving a risk free return; when you pay down your debt you will no longer be charged interest on that amount. The money you save on the interest is your “return”.
- An additional benefit of paying off high interest debt is that you would be putting yourself in a better overall financial position and potentially increase your credit score.
Note that investing for the short term, where you are looking for low risk and relative liquidity is typically a different strategy than investing for the long term.
Pros:
- Risk Level: Risk Free
- Rate of Return: High, when paying off high interest debt
Cons:
- Not as straight forward if you have lower interest rate debt
2. Municipal Bond
Municipal bonds are issued when state or local governments need to raise money. Municipal bonds are considered only slightly more risky than U.S. securities, mainly because municipals have in the past paid less …[than] owed or defaulted on the issued bonds. Two recent municipal examples:
- Detroit in 2013 (largest US city to declare bankruptcy) paid less than they were owed on their bonds.
- In July, 2016, Puerto Rico defaulted on their debt (first time a state or commonwealth has done so since 1933.)
On Wall Street these municipal bonds are often called “munis” and are classified into two segments, determined by how the issuing entity gets the funds to pay the bondholders. The two segments are:
- General Obligation Bonds (GO) which are issued for entities that possess the ability to levy and collect taxes. Given these entities can levy and collect taxes, typically the bonds are issued for free public use such as schools, prisons, police, fire rescue, and government buildings.
- Revenue Bonds that are issued for entities that possess the ability to charge fees or generate other charges by the specific public project being funded. An example being a municipality issuing revenue bonds to fund construction on a new sports stadium, the revenue attained from ticket sales, parking fees and concession sales would go towards paying the interest payments and principal of the bonds issued.
You can buy municipal bonds directly from the municipality or invest (with investment firms) through bond funds (mix of municipal bonds.)
Pros:
- Risk Level: Low
- Rate of Return: Middle
- Liquidity: Middle
Cons:
- Chance of default, ideally offset by rate of return
3. Corporate Bonds
Similar to municipal bonds when a corporation needs to raise money they can pursue two types of financing; equity financing and/or debt financing. The equity financing is stock offering while the debt financing comes in the form of a corporate bond.
- Corporate bonds are agreements between a corporation and an investor(s) for which the investor lends money to the corporation for a agreed upon time frame at a agreed upon interest rate. There are four types of corporate bonds:
- Secured Bond – backed by some sort of collateral in case the of default
- Unsecured Bond – backed by just the corporation’s promise to pay
- Convertible Bond – the bond can be converted to the corporations common stock (at the option of the bondholder, at a predetermined price)
- Zero-coupon Bond – these bonds have no interest payments, they are sold at a discount or premium to the face value of the bond.
Pros:
- Risk Level: Low to Mid (dependent on Secured or Unsecured Bond)
- Rate of Return: Middle
- Liquidity: Middle
Cons:
- Chance of default, ideally offset by rate of return
4. Treasury Inflation-Protection Securities (TIPS)
Inflation protection securities are fixed-income securities that are indexed to inflation; this is a simple and effective method to cut out one of the biggest risks with fixed income securities, inflation risk…These TIPS are backed by the United States government which make them considered a very low risk investment.
- Once these securities are issued the principal is adjusted each month for inflation (up or down) based on the Consumer Price Index for All Urban Consumers, or CPI-U. The Treasury inflation-protection security coupon rate stay constant, but the dollar amount received would fluctuate with the change in principal each month (as adjusted for inflation).
- TIPS are issued at a minimum amount of $100 and can scale up in increments of $100.
- TIPs are issued in 5, 10, or 30 year terms and can be held to maturity or sold before.
- Treasury inflation-protected securities can be purchased in electronic form at TreasuryDirect.gov
As an example:
Let’s assume you invest $100 in a TIPS at the beginning of the year; with a coupon rate of 2%. Let’s say at the end of the year the average inflation rate (as measured by the CPI-U) comes in at 5%.
With the average inflation rate of 5% the new principal amount would be ($100 x 5%) = $105. The coupon rate is constant at 2%; so the resulting interest payment would be ($105 x 2%) = $2.10 over the year.
Pros:
- Risk Level: Risk Free
- Rate of Return: Low
- Liquidity: Middle to Low (dependent on term)
Cons:
- Return my be under inflation
5. Savings Accounts
Online Savings Accounts: A more traditional approach for holding your money in the short term is an online savings account. The benefits of an online savings account is that your investment is risk free (if under the FDIC coverage amount of $250,000) but can still offer you a modest return.
- several banking institutes online offer rates over 1% in savings accounts.
- your investment would be extremely liquid in an online savings account meaning you would not [be] at risk of market fluctuations or early withdrawal fees.
Money Market Accounts: are very similar to savings accounts in that they both are insured by FDIC and essentially risk free. The main two differences are how you are allowed to retrieve your money and certain interest rate tier structures.
- Money markets allow you to write checks and use debt cards, while savings accounts typically would require you to retrieve your money via wire transfer or in person at brick and mortar location.
- In this current market condition many online savings accounts offer a higher interest rate for the same risk level so that is why we feel online savings accounts is a better option at this point.
Pros:
- Risk Level: Risk Free (up to FDIC deposit limits)
- Rate of Return: Low
- Liquidity: High
Cons:
- Return my be under inflation
- Limit on transactions per month
- Withdrawal method limitations
6. Certificate of Deposit (CD)
A Certificate of Deposit is essentially a period of time deposit where there is a fixed end date (maturity date) and known fixed interest rate of return.
- …the deposits (at commercial banks or credit unions) are insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA) which provides essentially a risk free investment.
- CDs are also generally issued electronically and typically automatically renewed at the end of the term, which provides some convenience.
- Certificate of deposits have many different maturity time frames to choose from and the dollar amounts can be issued in any denomination.
The downside of a CD is that your money is locked up for the specified time frame. That’s not to say you could not withdraw your funds, but you would incur a penalty that would basically offset any interest you would have earned.
Pros:
- Risk Level: Risk Free (up to FDIC deposit limits)
- Rate of Return: Low
- Liquidity: Middle to High (dependent on term)
Cons:
- Return my be under inflation
- Early withdrawal fees
It is important to consider your overall financial situation and determine which investing strategy best fits your goals. When looking for a short term investment, the above options could work well for you. Understand that the investment world changes often and you should continually evaluate options as they are presented to you…
For all the latest – and best – financial articles sign up (in the top right corner) for your free bi-weekly Market Intelligence Report newsletter (see sample here) or visit our Facebook page.