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Whether any investment is appropriate for your portfolio depends on your projected holding period. Money you can sock away for five to 10 years or longer is probably best allocated to stocks. But when it comes to short-term investments, stocks are not as ideal given the unpredictability of the market. The best short-term investments are instead those that put preserving capital ahead of growing it.
With this in mind, here are three ideal short-term investments.
1. Certificates of deposit
Certificates of deposit bridge the gap between savings and investing. A certificate of deposit is a deposit that is locked in at a bank for a set period of time, from one month to as long as 10 years. In exchange, the bank will pay you a higher interest rate on your savings, knowing that you intend to keep your money in the bank for a longer period.
Be sure to shop around. Most national banks pay very little on their certificates of deposit. Many smaller banks, however, are frequently looking for long-term deposits, and willing to pay a premium interest rate for your savings.
At the time of writing, Bank of Americaoffered a rate of 0.15% on its five-year certificates of deposit. Meanwhile, Synchrony Financialoffered a rate of 2.25% per year on its five-year CDs.
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One benefit to CDs is that they are given full FDIC protection. In the event the bank fails, the FDIC will protect investors from loss, up to $250,000 per depositor, per bank. Always make sure that you buy CDs from FDIC-insured institutions. Many institutions with bank-like names are, unfortunately, not FDIC insured.
Finally, keep in mind that most banks charge a penalty for cashing in a CD early, often 5%-10% of the amount invested. Thus, you have to be confident that you absolutely won't need the money before the certificate of deposit matures before buying a CD.
I-Bonds purchased from the U.S. Treasury can be a great short-term investment. I-Bonds are a way to lend money to the U.S. government at a fixed rate plus inflation. Thus, your money is guaranteed to grow at least as fast as the rate of inflation over time, protecting your spending power.
Unlike CDs, I-Bonds also allow you to access your money early, with only a small penalty. You can cash in any I-Bond after one year. If you cash in an I-Bond within the first five years, you'll incur a small penalty of just three months interest. I-Bonds held for five years or longer can be cashed in with no penalty at all.
In addition, it's easy to buy I-Bonds online direct from the U.S. Treasury in an amount up to $10,000 per Social Security Number per year. In other words, a married couple could invest up to $20,000 in I-bonds in a single year.
3. A high-quality bond fund
Short-term bond funds offer competitive returns with low risk in addition to nearly immediate access to your money should you need it. Vanguard Short-Term Investment-Grade bond fund (VFSTX) offers a competitive 1.84% yield, with a minimum investment of just $3,000.
The only drawback of a short-term bond fund is that your investment is not guaranteed. In market panics, such as the one from 2008-2009, a bond fund can generate a negative return. Those who owned Vanguard's fund saw their investment lose 8% of its value from August 2008-December 2008. By mid-2009, however, investors were back to even, and have enjoyed positive returns ever since.
A short-term bond fund is a riskier choice than an I-bond or CD, but the risk should be weighed with the benefits: There are no penalties for withdrawing your money on a short timeline as there are for CDs or I-Bonds. In addition, you can add money to Vanguard's fund at any time, in any amount greater than $1, making it a very convenient short-term investment vehicle.
The article 3 of the Best Short-term Investments originally appeared on Fool.com.
Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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