The Optometrist’s Guide to Short Term Investing
(1) What is a Short-Term Investment & Why are they Only Held for Less Than 5 Years?
(2) Overview of 7 Top Short-Term Investments (2023) + Comparison
(3) Three Features For a Good Short-Term Investment
(4) Three Tips To Be Successful when investing for less than 5 years
Every optometrist/investor will have long term financial goals (such as retirement or saving for their kid’s college) or a short term goal such as buying a house or wedding. So if you are looking to invest money for the short term, you are probably searching for a safe place to stash cash in order to access these funds in the near future - usually less than 5 years.
With the recent volatile market and pending economic recession, many investors are looking to hold their cash in a relatively safe place, especially as our economy faces surging inflation. In this article, we will talk about short term investments and where we can place these funds, aside from just storing cash.
What is a short-term investment?
The most important characteristic of short-term investments is that they are safe and liquid. Investors are often using funds that are reserved for a down payment, wedding or future business purchase. Usually their short-term investments are withdrawn within three to five years, but not longer than five years.
This is opposite from longer term investments with time horizons that are greater than 5 years, where stocks can offer the potential for significantly higher returns. For example, the stock market has historically risen an average of 10% annually over long periods of time. Thus, the longer time horizon gives you the ability to ride out the ups and downs of the stock market.
Why is short-term investment only held for less than 3-5 years?
Studies show that on an average, it takes about 5 years for the stock market to recuperate some of its losses and go back to baseline (or zero) after a long bear market period or significant market correction.
But it is definitely not guaranteed that the market will recover to baseline after a crash. Let’s take a look at the Great Depression of the 1930s for example. It took them almost 10 years to fully recover. Fortunately, this scenario rarely occurs, however it does give us a glimpse of the inherent risk of the stock market.
What are the pros and cons of short-term investments?
The safety of short-term investments comes at cost, which is lower return, compared to long term investments. If you invest for the short term, you will be limited to certain types of investments.
Short-term investments do have a couple of advantages. They are extremely liquid so you can get your money whenever you need to. Also, the investment tends to be much lower risk. That being said you won't see the latest crypto or NFT trend listed in these assets.
Overview of 7 Top Short-Term Investments (2023)
Here are a few of the best short-term investments that we recommend for OD investors in 2023 ranking from safer with lower returns to riskier with higher returns.
(1) Money market accounts
- Historical return =0.50-1.30%
A money market account is an interest-bearing account that you can open at banks and credit unions. Usually your local bank or credit union can offer these accounts. They tend to require a bigger minimum deposit and balances compared to online high saving accounts.
Similar to most bank products, your money is FDIC-insured updated to $250,000 per account owner.
They are very similar to online high saving accounts but often come with debit cards and/or physical checks for better access to your cash. But similar to online high saving accounts, there are limits to how many times you withdraw per month (usually 6 times).
(2) Online High-yield saving accounts:
- Historical annual return= 1.50-2.25%
Usually offered online, a high-yield savings account at a bank or credit union is usually a good alternative since they are highly liquid, and insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 at banks and by the National Credit Union Administration (NCUA) at credit unions, so you won’t lose money in extreme cases. You can add money anytime and allow up to six cost-free withdrawals or transfers per statement cycle.
"For any bank product like a money market account, high saving account or CD, your money is "safe". The FDIC adds together all single accounts owned by the same person at the same bank and insures the total up to $250,000."
(3) Cash management accounts (CMA)
- Historical return= 0.15% to 2.55%
CMAs are offered by robo-advisors, mobile trading apps and online investment firms such as Fidelity & Wealthfront. These digital platforms are not banks, so when you keep money in a cash management account, it’s “swept” into a partner bank overnight.
How does it work? Cash management accounts keep your money safe and pay interest by dividing your deposit into multiple accounts at different banks. For example, if you deposit $1 million into a cash management account, the brokerage might put sums of $200,000 in accounts at five different banks.
Distributing the cash among the five banks enables all of your $1 million to be insured — rather than just $250,000 of it, which is the standard FDIC insurance coverage limit per FDIC-insured bank, per depositor, per ownership category.
It is also covered by Securities Investor Protection Corporation (SIPC) during the temporary transfer between banks which has a limit of $500,000 cash and securities per account, but often requires the involvement of the Securities and Exchange Commission (SEC) for any claim; so be careful holding too many funds in these accounts.
"Cash management accounts (CMA) with your brokerage are a great way to hold cash of up to $1,000,000 since they are able to lessen the risk by dividing your fund into different outside banks where each account will be FDIC insured, up to $250,000 each"
(4) No-penalty certificates of deposit (CD)
- Historical 1 year CD return= 3.25-3.50%
A no-penalty certificate of deposit, or CD, lets you avoid the typical fee that a bank charges if you cancel your CD before it matures. CDs are time deposits, meaning when you open one, you’re agreeing to hold the money in the account for a specified period of time, ranging from periods of weeks up to many years, depending on the maturity you want. In exchange for the security of having this money in its vault, the bank will pay you a higher interest rate.
CDs are insured by the FDIC since they are bank products, so you won’t lose any money on them up to $250,000. The risks are limited for a short-term CD, but one risk is that you may miss out on a better rate elsewhere while your money is tied up in the CD.
In the past, CDs are typically less liquid than other short-term investments on this list, but a no-penalty CD allows you to avoid the charge for ending the CD early.
You can find CDs at your bank, and they’ll generally offer a higher return than you could find in other bank products such as savings accounts and money market accounts.
(5) Money market mutual funds
- Historical Return: 0.61% to 2.87%
Don’t confuse a money market mutual fund with a money market account. While they’re named similarly, they have different risks since one is a bank product while the latter is a market-based product. But both are good short-term investments.
As mentioned above, a money market mutual fund is NOT a bank product but rather a market-based product because it invests in short-term securities, including Treasury bonds, municipal and corporate debt, as well as bank debt securities - but it’s a mutual fund. You’ll pay an expense ratio to the fund company from the assets being managed and they usually require a minimum investment of $1,000-$3,000. But most money market mutual funds within your brokerage account have no minimum requirements.
Every investor will have these accounts in their brokerages such as Vanguard or Fidelity, essentially where the brokerage holds your “settlement” money between transactions. This is a great option for investors who want to keep everything in one place along with their stocks for buying opportunities such as “buying the dip”! Lastly, this is extremely liquid as you can withdraw as often as you desire within 2-3 business days.
Although regarded as fairly safe especially if placed within a well-established brokerage like Vanguard, please note that your money is NOT FDIC-insured.
Some of our favorite money market mutual funds are Fidelity Money Market Fund (SPRXX) and Vanguard Federal Money Market Fund (VMFXX)
(6) Treasury ETFs
- Historical Annual Returns= 2.50-4.75%
First, let’s talk about what makes up this ETF. These funds consist of U.S. Treasury bonds (often called T-bonds), which are a fixed-interest debt security issued by the U.S. Treasury Department to raise funds to finance Uncle Sam’s spending requirements. It often pays out dividend interest every 6 months before the end of the maturity period of 10-30 years.
While T-bonds are considered the safest form of investment since they are backed up by the US government, the downside is that you need to hold them for a minimum of 10 years for the maximum return - which kind of defeats the purpose of short-term investment, making it a fairly illiquid asset. However, you do have the option to sell after 45 days. In addition, they do require a minimum purchase price of $1,000, and are sold in $100 increments, often via TreasuryDirects.gov
Hence, why we usually recommend going the ETF route, which is an effective, low-cost way to get exposure to Treasury bonds, while being able to sell it at any time similar to a stock.
Word of caution for investors: while over a 30 years period, these types of Treasury ETF return an annualized 4.75%, they are extremely volatile during a low-interest environment like 2020-2022 where they lost an annualized return of -9%. So proceed cautiously!
"Treasury ETFs are market influenced and can be volatile, but offer higher return. If you’re looking for ETFs that invest in long-term Treasuries, we recommend iShares 20+ Year Treasury Bond ETF (TLT) and Vanguard Long-Term Treasury ETF (VGLT)."
(7) Short-Term Bond Index ETF
- Historical annual return: 3.00-3.50%
With a bond index ETF, you can buy a diversified selection of bonds usually in the short or intermediate ranges. These ETF invest in corporate and other investment-grade U.S. fixed-income issues such as US treasury bonds.
This diversification means that a single poorly-performing bond won’t hurt the overall return very much. The bond fund will pay interest on a regular basis, typically monthly.
In addition, similar to a stock, they are highly liquid since it can be bought and sold on any day that the financial markets are open. You can purchase them at virtually any online broker that offers ETF and mutual funds.
Word of caution for investors, while over a 30 year period these market-based short-term bond ETFs return an annualized 3.50%, during low-interest rate periods like 2020-2022, the return can be extremely low or even negative.
"Some of our favorite short-term bond ETFs are Vanguard Short-term Corporate Bond ETF (VCSH) and Vanguard Short-term Bond ETF (BSV). Remember that these are highly influenced by the market, so they will be volatile in the short term."
|When you need the Money by:||Investment options||Historical Interest Rate||Risk|
|1 year or less||High-yield savings and money market accounts, cash management accounts||~2.8%||Low risk and certain accounts are backed by the FDIC.|
|2-3 years||Treasury bonds, Bond ETFs, CDs||3.5% or more||CDs and Treasuries bonds are safest, corporate bond funds not as safe|
|3-5 years (or more)||CDs, bonds and bond ETF funds, and even stocks for longer periods||3% or more (but significantly more if you are investing in stocks)||CDs and bonds are relatively low risk compared to stocks, which can fluctuate a lot and are higher risk.|
What are 3 factors for a good short-term investment?
Short term investments have many things in common, but they are usually valued for the following reasons:
- Stability: They don’t fluctuate too much in value, unlike bonds or stock, so you can rest assured that your money will be there when you need it. Often they are protected by FDIC insurance up to $250,000 or have a government guarantee like treasury bonds.
- Liquidity: Offers high liquidity, which means you can access at any time for your future financial needs. While CDs are great, they are often charged a penalty for early withdrawal, unless you specify a no-penalty CD with your bank.
- Low transaction fees: You need to keep costs low because there is no reason to pay a high expense ratio for an actively managed money mutual fund when you are only holding it for maybe 1-2 years.
Keeping these 3 factors in mind will make sure that your money is NOT at risk and will be fully accessible when you need to use it.
What are 3 Tips for Investing 5 years or less?
It is a completely different strategy when you are investing for the short term since your time horizon is significantly shorter than money reserved for things like retirement. So you need to carefully approach short term investments with the following mindset:
- Expect Lower Returns: You are not going to be bragging about the 1-3% that your CDs return at any parties compared to your Tesla stock, so set your expectations appropriately.
- Safety is important: You want to make sure your money is there when you need it, so it is okay to get a little less return. Aim for accounts that are FDIC-insurance like high-yield savings accounts.
- Pick your investment based on your time horizon needs: Don’t choose a 5 years CD that produces a higher return, when you need the money in 2 years. Calibrate your investment type to your financial goals.
Not all short-term investments are equal: Bank products like high yield savings accounts are FDIC-insured, so it is guaranteed that you won’t lose the principal amount of at least up to $250,000. Market-based products (even safe ones like short-term bond ETFs) can decline over short periods like the 2020-present COVID era where there was actually negative return. proceed carefully.
Short-term investing is an important tool that all optometrists need to have in their portfolio, because it allows us to accomplish many of our financial goals throughout our lives such as saving for a house. The bottom line is these are great investments for individual investors who are looking for both liquid and stable options to grow their wealth.
The options are plenty: from CDs to bonds and high-yield savings accounts, it's only up to each investor to do their homework based on their time horizon.
Want to learn how to build your own portfolio? Check out The Optometrist's Guide to Investing 101
Want to get a full blueprint on How to start? Buy our Book The Optometrist's Guide to Financial Freedom
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