Every few weeks, someone emails me asking for the best short-term investment.
They're usually saving for their first home and they want to optimize their earnings. They don't want to gamble it in some bitcoin. Or put it all on black. They want some kind of return without putting it at risk.
The 0.01% from their brick and mortar bank isn't cutting it.
When I think about my money, I think of it as being in time capsules. Anything I need in the next five years must be safe.
100% no questions asked, non-volatile and safe.
I still want to get a few cents in interest though. With inflation, anything in cash is losing purchasing power every single day. If I can slow down that process, I'm all the happier.
What is a “Safe” Investment?
For the purposes of this list, I look at two types of safe investments. 100% safe and “mostly” safe (low-risk).
When you talk about investments, they come in two main varieties – debt and equity.
With debts, you lend your money to an entity and they pay you interest. With equity, you buy a piece of something and can sell that piece later, hopefully for a nice gain. Neither are inherently safer or riskier.
With debts, the safety of that loan depends on the entity. Most safe investments are structured as loans. Riskier investments are often structured as ownership.
With a loan, I'll give you a little extra interest if you promise you won't ask for your money back sooner than I expect. If you lend me money for 12 months, I'll give you one interest rate. If you lend me money for 30 years, I'll give you a higher one. If you want your money back earlier, I might claw some of that interest back. (this is, essentially, what happens with a certificate of deposit)
With ownership, you buy a piece of me, my business, or some other asset. You may get a periodic payment (dividends) but the bulk of the return is on equity appreciation when you sell. It's riskier because the ownership piece can go up or down in value. Sometimes it can go up and down in value independent of the asset, like with publicly traded stocks.
Safe investments are loans to entities deemed safe. Lending money to the United States Government is safe because it's likely to be repaid. Lending money to your cousin and his new business venture is less safe. Lending money to your 6-yo nephew is even less safe.
Safety does not mean you will not lose money or purchasing power. Inflation is an ever-present spectre and it's why you could get a pack of baseball cards for 5 cents many many years ago (though you could probably still find bazooka gum for a nickel!).
Interest rates are also a concern. As interest rates rise, any fixed interest rate investment loses relative value. If you try to sell it on the market, it'll be worth less than what you paid to get into it (in the case of a bond fund). If you hold it until maturity, you'll still get all your safe money back. Safe means your principal is safe.
What are some safe short-term investments?
Earn Bank Deposit Promotions
Earn bonuses at banks running huge sign-up promotions. Banks are competing for business and that includes giving you a few hundred bucks to open an account. In most cases, you deposit some money, set up a direct deposit, and wait for the cash.
I keep an updated list of the best bank promotions with a minimum $100 bonus.
You have to keep an eye on the minimum deposit amount (often to avoid a maintenance fee) and other requirements but the money is out there just for the taking.
Online Savings Account
Your brick and mortar bank pays you nothing in interest. Those 0.01% APY rates are a farce.
But online banks will pay you at least 1-2% each year. You won't get rich, you won't even beat inflation, but you're beating brick and mortar banks.
If your #1 bank isn't online, you're giving up easy money. Online banks have solved every banking situation for their customers. With large ATM networks, or ATM surcharge refunds, powerful smartphone apps including remote check deposit, and responsive online customer service – there is no reason you shouldn't have an account.
(one exception, depositing cash is still difficult but how often do you do that?)
Certificates of Deposit
Certificates of deposit are the textbook example of trading flexibility for more interest. Certificates of deposit are popular because they're FDIC insured and will not lose value. Certificates of deposit are easy to compare because most banks offer the same terms.
The only difference to look at (beyond the interest rate) is the early withdrawal penalty, what you pay (or surrender) by closing a CD early. Most banks will take out 90 days of interest on CDs with a term shorter than 12 months, 180 days on terms greater than 12 months. Banks that offer 60+ month CDs may take as much as 365 days of interest.
One anomaly in the typical schedule is Ally Bank, who only charges 60 days of interest on CDs with a term of 24 months or less. As far as I know, they're the only bank that charges just 60 days of interest on a 2-year CD.
You can increase your total return by taking advantage of CD ladders. This is when you stagger your savings into longer maturity certificates of deposit. More details are in the linked article explaining how to use them for emergency funds.
Brokered Certificates of Deposit are slightly different than regular bank Certificates of Deposit, so I broke them out into their own category. They're called “brokered” CDs because you buy them through a brokerage firm, like Vanguard or Fidelity. A brokered CD is still initiated by a bank, so it has the same FDIC insurance protections as regular CDs, they're just purchased through brokerages.
What's nice about brokered CDs is that the brokerage will sell you CDs from a variety of banks. This can include better yields at obscure banks you may have never thought about. This also means you could, in theory, sell the brokered CDs on the market but generally speaking the market is small for these.
Brokered CDs can also come in two varieties – callable and non-callable. Callable means the bank can “call” the CD and buy it back. Regular CDs can also be callable and non-callable, though most are non-callable. Callable CDs typically have higher interest rates because you take on more risk – the bank can simply call the CD if they can get rates lower.
Lastly, the minimum deposit amount for most brokered CDs will be much higher.
Rewards Checking Accounts
Rewards checking accounts were popular about a decade ago and have since fallen a bit out of favor. Back then, you could get 5% APY at an online bank and regular banks were looking to compete. Some offered as much as 10% APY on your savings as long as you met a few requirements.
Among other simpler requirements, like electronic statements, the most important requirement was using their debit card at least 10-15 times each period. Banks were able to give you 10% APY because they were passing on some of the transaction fees from the debit card.
Today, rewards checking accounts are rarer but still available. There is a hidden cost. If you use your debit card 10-15 times a month, that's potential cashback you're surrendering by not using a cashback credit card.
Treasury securities are bonds sold by the United States Treasury. They are backed by the full faith and credit of the United States Government.
There are a ton of Treasury bond products (this is a very brief recap of each):
- Treasury Bills: T-bills are bonds you buy at a discount to its face value (par value). When the bond matures, you're paid the par value.
- Treasury Notes: T-notes are bonds you buy at face value but pay interest every six months until they mature (maturity terms are 2, 3, 5, 7, and 10 years).
- Treasury Inflation-Protected Securities (TIPS): TIPS are marketable securities (so you can sell them on the secondary market) whose principal is adjusted by the CPI (Consumer Price Index). When the TIPS matures, you get get the adjusted amount or the original principal, whichever is greater (ie. deflation doesn't hurt you).
- Treasury Bonds: Treasury bonds are only available with a 30 year term and pays interest every six months until it matures.
- Floating Rate Notes (FRNs): FRNs are two year notes that are sold below, at, or above face value. When it matures, you get face value.
- Series EE Savings Bonds: Series EE bonds are bonds that earn a fixed rate of interest, announced every May 1st and November 1st, for up to 30 years. Interest is subject to federal taxes. Qualified taxpayers can exclude all/part of the interest if it is used to pay for qualified higher education expenses.
- Series I Savings Bonds: Series I bonds are bonds that earn a fixed and floating rate of interest, adjusted and announced every May 1st and November 1st based on the CPI, for up to 30 years. Interest is subject to federal taxes. Qualified taxpayers can exclude all/part of the interest if it is used to pay for qualified higher education expenses.
Alternatively, you can invest in mutual funds that hold Treasury bills (among others). This is “riskier” than holding the bills because the value of the fund can change based on other factors. When interest rates rise, the value of the fund will fall. The value of a Treasury bill will go down as interest rates go up and the fund will reflect this.
For this added risk, you get the flexibility of redeeming your shares when you want.
Tax Lien Certificate Auctions
When a property owner fails to pay a local or county tax, the government will put a tax lien on the property. The government still wants their money so they auction these leins.
Investors can buy the tax lien at auction, pay the government, and collect the lien plus interest. The interest rate is set by the law by the state. If the property owner doesn't pay the lien off during the redemption period, the lien holder can foreclose on the property.
Liens are first in line for payment, ahead of even first mortgages. What you'll often see is the bank paying off the lien because they don't want to lose the house.
Liens are “safe” because the house acts as collateral. There is still risk in the entire process because of information. You could go to an auction and find all the liens you like are not available, because someone paid it off. You may win a lien whose property is worth far less than you expected.
It's quite a bit of work. You have research property, attend auctions, follow up liens and try to collect. Liens can expire worthless. It's not like filling out a form and depositing money into a CD… so do your homework.
(this is one of the common ways you can get exposure to real estate with limited risk and low dollar amounts)
Low Risk Investments
The list of 100% “safe” investments is very short.
There are relatively low-risk investments that may make sense.
There's a term in investing known as the risk-free rate. It's the rate of return you can get on an investment with zero risk. For most investments, the risk free rate is whatever the latest auction of the 30-year Treasury bond is offering.
Technically it's not risk-free. The United States Government can collapse. But when most of your money is in United States dollars, a government collapse would make your money worthless. Whether you had a 2% return or a 10% return is irrelevant.
You better have some guns and gold. 🙂
Low-risk investments are investments that give you a bit more than the risk-free rate… but not that much more.
Municipal Bonds and Funds
Municipal bonds are bonds issued by a municipality, like a county or other local authority.
They use these funds for a a variety of projects, from construction to schools, but they're backed by the municipality. The interest is exempt from federal taxes and usually most state and local taxes.
They're low risk because the municipality can (and some have) default on that obligation. You may have heard that Puerto Rico had trouble making bond payments. Those bonds are municipal bonds.
A municipal bond can be a general obligation (GO) bond or a revenue bond. A GO bond is a bond that isn't backed by a revenue source. A revenue bond is one that has a revenue source, like a toll road or some other tax.
You can buy municipal bonds from the municipality or through bond funds. If you buy direct, expect a high minimum investment amount. Bond funds offer greater flexibility and diversification.
For example, Vanguard's (VWITX) is a municipal bond fund that invests in a variety of municipal bonds with an intermediate-term (5-6 years). Every mutual fund company has a variety of these types of muni bond funds.
Short Term Bonds and Funds
This is slightly riskier but you can invest in short-term corporate bonds for a slightly higher yield. Much like other bonds, they're backed by the underlying entity, which in this case are companies. Companies are more likely to default than municipalities, so the risk is higher. Much like muni funds, you can find short term corporate bond funds too.
That concludes the list of low-risk investments we're aware of and comfortable suggesting.
I'm of the mind that if you need it to be safe, stick with the safe “investments” and avoid low risk. Low risk is not the same as no risk! If you need the cash in the near future, you'll regret putting it in any kind of risk for a couple percent interest!