Somewhere between saving for the very distant future called retirement and saving for your birthday party next week, you probably have some other short term financial goals in mind.
What are short-term goals?
Short term goals are goals you have in the next 1-3 years. You might be saving up for things like:
1. a down payment for a new home or car
3. a capital for a business idea you want to test
4. equipment upgrade for your hobbies
Saving for short term goals is a big challenge given the limited time and income we have. Luckily, there are some short-term investment vehicles that can give your savings a little bump.
Some people, however, shy away from investing because it “sounds” too risky. But that is not true for all types of investments.
Dealing with investment risk
In investing, there is what they call an ‘investment risk pyramid’ and at the base of that pyramid are the less risky investment types. As you go up to the apex of the pyramid, the risk multiplies. Examples of those investment types are the speculative world of currency trading, precious metals and highly volatile stocks. Understandably, there is an allure to these kinds of investments as they offer high returns in exchange for tremendous risk.
But as a person who wants short-term goals, you should never dabble into these high-risk investments. Why? Because you have a limited time frame and you won’t be able to ride out the natural cycles of the market. If you need your money after 3 years but you are down by $5000 because of a losing stock, then you fall short of your goal.
Instead, you need to go for more secure investments which we will discuss later on.
First, the question: if there is a risk involved, should I just save rather than invest?
Unfortunately, there is no such thing as risk-free investment. Even if you put your money under your mattress, there is risk of losing it to fire, to burglars, or even to your kids who want the occasional treats from mom and dad.
Moreover, inflation and the rising costs of commodities and services cause your money to lose value. You have to have some financial instrument to at least absorb the effects of inflation.
That’s where investing comes in.
Investing short term allows you to put your money in low-risk asset types, and at the same time earn steady return compared to just putting your savings in a piggy bank on your bedside table.
A Note on Liquidity
Many people dive head in first into the world of investing without even knowing their time frame or their deadline for their goal. By failing to do so, some of them invest in assets whose liquidity rate does not match their goals.
Liquid assets are much easier to cash out. If you want to buy and sell real estate properties as a form of investing, then you should know that real estate investments have low liquidity rate. Meaning, you don’t get to sell them right away, therefore, you cannot convert it to cash at the snap of your fingers. If you have a shorter time frame, you need investments with a high liquidity rate. So what are the best investments for my short-term goals?
Online savings account/Checking accounts
Better than the piggy bank, online savings and checking account are FDIC insured and they earn interest, although at a dismal rate. Liquidity rate is very high; you can just go to a nearby ATM and take out your money in case you need it (hopefully, not for a major steak craving). If you put your money in big commercial banks, the risk of losing it is almost zero, unless they close, which rarely happens. Now, not all people would even consider this as an “investment,” but compared to stashing cash at home, this is far better. “Thrift” banks are also an option. Thrift banks are smaller banks tailored to the needs of individuals, not corporations. These types of banks operate in small communities and may offer more competitive interest rates to depositors than do commercial banks. But being a smaller bank, thrift banks may carry higher risk compared to the banking giants.
Certificates of Deposit
Also known as the time deposit, CDs offer slightly higher returns (around 1-3%) compared to savings or checking account but in exchange for a lower liquidity rate. Like savings accounts, CDs are quick and easy to open and are also insured by the FDIC. Time deposits have maturity dates, from several days to a few months or even years (with various increments) and their interest rates vary depending on the bank and the prevailing rates. As a short-term investor, you should choose a maturity date that’s the same or close to your investment time frame.
Low-risk pooled funds
Pooled funds or “mutual funds” are funds that investment firms gather from individual investors to be placed in a portfolio of different asset types.
Low risk pooled funds may include:
Money market funds
Money market funds are invested in low-risk government securities such as Treasury bills and commercial short-term loans. Unlike savings or certificates of deposit, money market funds are not federally insured and can fluctuate in price, although the fluctuations are quite minimal. Investing in money market funds allow you to earn returns based on the performance of the portfolio being handled by your investment company. Sure the returns aren’t as high as stocks but it keeps your principal safe and that’s more important for your short term goal.
Bond funds are mutual funds primarily invested in bonds. A bond is a debt security, where an investor (bond holder) lends money to a borrower (bond issuer) for a defined time period at a specific interest rate, through which the bond holders achieve their capital gains. As they are considered fixed security asset, bonds typically carry lower risk and, therefore, lower gains than equities or stocks. Then again, the equities market is too risky for your short term goals.
Unlike your Traditional IRA or 401(k) plan, a Roth IRA allows you to invest short term without getting hit with an early withdrawal penalty and income tax, because this type of retirement fund is funded by your after-tax dollars. You can take out your principal whenever you want.
With Roth IRA, you get access to access to different asset types like stocks and bonds. This, of course, has potential for a higher risk but because it is managed by a professional investment company, the risk is mitigated.
Now this is the safest and fastest way to save for your short term goal! This may not be a type of financial instrument, but it can be a great catalyst for your savings goal.
For years, you simply got used to living on an income that is intercepted by credit card bills. Now imagine what a relief it is to get out of a $30,000 debt. If you have that credit card debt racking up 15-18% interest, eliminating it would feel like you now have extra 15-18% more income. By eliminating debt, you free up your cash flow; you get more out of your income. You have more money. It’s that simple.