What Short-Term Investments Are Generally Considered Safer?

Short-term investing isn't inherently safe, but certain investments can provide liquidity, stability and a reasonable return with minimal risk. As the name suggests, these investments typically mature within one to three years, making them most suitable for those who need access to the funds in the near future. Safety, in this context, means a lower risk of losing your principal, which is especially important when a major life event or financial goal is on the horizon. From government-backed securities to high-yield savings accounts, there are a number of safe short-term investment options that offer security. 

A financial advisor can help you find a balance of short- and long-term investments suited to your needs. Connect with your advisor matches today.

What Is a Short-Term Investment?

A short-term investment is a financial asset that's designed to be held for a relatively brief period of time. This time frame is typically less than three years, though it can sometimes be as brief as a year or less.

Safer short-term investment options include high-yield savings accounts, certificates of deposit (CDs), Treasury bills and money market funds. But again, just because an investment is short-term in nature and generally considered to be safe, it doesn't mean there's no chance of losses.

There are some short-term investing strategies that are much riskier, such as day trading or swing trading in stocks, options and cryptocurrencies. While these methods can potentially yield lucrative gains, they also carry significant risk due to daily price fluctuations and major volatility swings.

For some investors, the primary goal of short-term investing is to preserve their capital, while earning a modest return. On the other hand, investors with a higher risk tolerance may be willing to accept higher risk for the chance of a higher return.

Short-term investments are also a popular choice when liquidity is a concern. For example, maybe you're saving up to buy a home next year. In this case, you need to be able to access your funds when it's time to make the down payment.

Before opting for short-term investments for any of these purposes, it's also important to note that investments (not CDs or bank accounts) that are sold within a year are subject to higher-than-normal tax rates. These come in the form of short-term capital gains rates, which are equivalent to the standard income tax rates of 10% to 37%. On the flip side, holding investments for at least a year and a day before selling them unlocks the more favorable long-term capital gains rates, which vary from 0% to 20%.

4 Types of Safe Short-Term Investments

When it comes to safe short-term investments, there are a variety of options that offer security while maintaining liquidity. These investments are generally low-risk and often backed by government guarantees or financial institutions, providing peace of mind for investors who want to protect their capital.

Below are some examples of safe short-term investment choices.

1. High-Yield Savings Accounts

A high-yield savings account is a savings product offered by banks or credit unions that pays a higher interest rate than traditional savings accounts. Often, these accounts are offered by online institutions as opposed to brick-and-mortar banks. High-yield savings accounts generally are federally insured up to $250,000 per depositor per account type, making them a very low-risk option. 

Liquidity is the primary benefit of a high-yield savings account. You can typically access your money at any time without penalties, which makes this a good option if you need to park cash for a short period without entirely locking it away. Just note that you are often limited to a certain number of withdrawals per month.

While the returns on high-yield savings accounts are not guaranteed to be substantial, they can be more favorable than those of standard savings accounts. Still, they may not provide the same growth potential as other investment options, so they are best suited for very short-term goals or as a safe place to hold emergency funds.

2. Certificates of Deposit (CDs)

CDs are time deposits offered by banks that pay a fixed interest rate for a specified term. CDs are generally considered a very safe short-term investment because they are insured by the FDIC or NCUA up to $250,000 per depositor, per bank. 

The key to CDs is that they lock in your money for a set period, which can range from a few months to several years. In return, you receive a fixed interest rate that is often higher than what you'd earn in a savings account, particularly compared to the best CD rates.

Liquidity is the main tradeoff you make with CDs. If you need to withdraw your money before the term ends, you'll likely face penalties. However, for investors who know they won't need immediate access to their funds, CDs provide a predictable return and are a secure option for short-term savings. Short-term CDs – meaning those maturing in less than a year – are particularly useful for investors who want stability but don't want to commit to a long investment period.

3. Treasury Bills (T-Bills)

Treasury bills (T-bills) are short-term government securities that mature in one year or less. They are considered one of the safest investments available, as they are backed by the full faith and credit of the U.S. government. T-bills are sold at a discount and pay out the full face value at maturity, meaning you earn the difference between the purchase price and the amount you receive at the end.

T-bills offer flexibility because they are available with different maturities, ranging from one month to one year. They are also highly liquid, allowing investors to sell them in the secondary market if they need access to their cash before maturity. 

While the returns on T-bills may be lower compared to other investments, their safety makes them an attractive choice for investors looking to park their money for a short period.

4. Money Market Funds

Money market funds are another relatively safe option for short-term investments. These funds invest primarily in high-quality, short-term debt instruments, such as government securities and CDs. These generally have lower risks compared to individual stocks and other, more volatile assets. 

Money market funds are also liquid, allowing investors to access their funds quickly though not immediately as in the case of, say, a savings account. And while returns are modest compared to riskier investments, money market funds can offer higher yield potential than some regular savings accounts. Though yields on money market funds can be minimal when interest rates are low, rising interest rates tend to increase yields.

Unlike savings accounts, however, money market funds are not insured by the Federal Deposit Insurance Corporation (FDIC). However, they are still regulated and tend to be conservative in their holdings.

Pros and Cons of Short-Term Investments

Short-term investing is often appealing to investors who are looking to take advantage of market fluctuations and make quick returns. However, it's a good idea to take your personal risk tolerance and goals into account, as well as the pros and cons of these strategies, before diving in.

Here are some of the potential benefits of short-term investing:

• Liquidity: Short-term investments are generally more liquid, allowing investors to convert their assets to cash quickly. This flexibility can be helpful if you need to meet unexpected financial needs or want the ability to seize a potential investment opportunity. 
• Quick returns: Short-term investments are geared toward rapid gains. This means you can potentially capitalize on market trends and earn returns within a shorter time frame. That makes it an attractive strategy for those who don't want to lock their funds away for the long term. 
• Flexibility: Since short-term investing doesn't require long holding periods, investors have the freedom to adjust strategies, rebalance their portfolios or shift funds based on market performance and personal goals.

Again, all investments and their respective strategies have their downsides. Below is an overview of the potential drawbacks of short-term investing:

• Higher risk: Market volatility can significantly impact short-term investments. Quick price swings can lead to sudden losses, making it risky for investors who may not have the capacity or desire to endure such extreme market fluctuations.
• Tax implications: As mentioned above, short-term gains on true investments are often taxed at a higher rate than long-term investments. This can reduce net returns, especially for those who may be in higher tax brackets.
• Lower returns: Many short-term investments that are considered to be safe – including bank accounts and bonds – often produce lower returns than riskier investments that are held for longer periods. 
• Time sensitivity: To be successful with short-term investing, investors must often continuously monitor market trends and asset performance. For some, this can be a time-consuming and stressful endeavor, as success  on some types of short-term investments hinges on precise timing and quick decision-making.

Tips for How to Invest for the Short-Term

When investing for the short term, it's important to focus on safety and liquidity. Here are a few tips to help guide your strategy:

• Prioritize capital preservation. Since your timeline is short, focus on investments that pose minimal risk to your principal. Safe short-term investments like high-yield savings accounts or T-bills can provide modest returns without exposing your funds to significant volatility.
• Consider your liquidity needs. Choose investments that allow you to access your money when needed. While some options like CDs may lock in your funds for a set period, others like savings accounts or money market funds provide easier access to your cash.
• Make sure to diversify your holdings. Even within short-term investments, it's wise to diversify across different asset types. This can help reduce risk and ensure you have a mix of time horizons to meet different financial goals.

Bottom Line

Safe short-term investments are a solid choice for investors who need access to their funds in the near future and want to minimize risk. Investment options like high-yield savings accounts, CDs and T-bills can offer stability and liquidity, making them ideal for preserving capital over short periods. When planning your short-term investment strategy, it's important to prioritize safety and match your investments to your financial goals and timeline.

Tips for Derisking Your Portfolio

• Over time, certain assets in a portfolio may grow faster than others, shifting the portfolio's initial risk profile. Rebalancing involves adjusting asset allocations back to target levels, which helps maintain a risk level aligned with your goals. This could involve selling some assets that have grown significantly and reinvesting in others that may be underperforming but align with long-term goals.
• A financial advisor can help you assess your risk tolerance and build a portfolio that’s aligned with your ability and willingness to take on risk. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.

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