What are Short Term Investments – the Complete Guide to Short Term Investments
Short term investment options comprise some of the most popular options in the world of investing. These investment options offer quick returns; they also ensure that our money is not tied-up in one investment for very long. Thus, short term investment options can often play a very useful role in our investment portfolio. If you are excited about short term investments and want a comprehensive understanding of these options, then we are here to help you. In this brief article, we will quickly and simply describe and explain the common short term investment options and their features.
What is a Short Term Investment?
Generally, investments that have a period of maturity of between 3 to 12 months are considered short term investments. Some experts include investments with a period of maturity of up to 3 years among short term investments. A common feature of short term investment options is that they may be readily (quickly) convertible to cash. (This is why some short term investment options are categorised as cash equivalents.) Thus, these options can provide a lot of liquidity along with returns on investment. Secondly, these investments are typically seen as low-risk investments – thus, short term investment options can be a very good way of safeguarding your capital.
All investment options carry some risk. One of the biggest sources of risk in the world of investments is uncertainty. A company that is a market leader in its industry today may struggle to survive 10 years from now. Companies that have not yet started operations may grow to become market leaders in the next few years. In the age of rapid technological changes, entire industries may disappear in the next decade and new industries (not present till now) may replace them. Thus, it can be very difficult to accurately predict which long-term investments would consistently be successful over the next decade and which would fail. Short term investments allow us to reduce this uncertainty drastically. While it may be nearly impossible to predict what would happen over the next 10 years, it is easier to understand what is likely to happen within the next one year. Thus, short term investments are generally seen as less risky than long-term investments.
In the world of investments, there is a simple rule about the relationship between risk and returns. The greater the amount of risk that an instrument carries, the higher would be the returns offered. Correspondingly, low risk instruments would offer lower returns. As short term investments are generally less risky than long-term investments, they often offer lower returns than long-term investments. For this reason, experts often advise investors to include a mix of short term investments and high return long-term investments in their investment portfolio. Do note that this advice would vary according to each investor’s investment goals as well as each investor’s ability to bear risk.
Common Short Term Investment Options
Now that you have understood the nature/attributes of short term investment options, you must be interested in knowing about the important (common) short term investment options. Let us look at the following list of short term investment options.
These are very common investment options. Investing in a bank account is equivalent to lending money to the bank. The bank, accordingly, pays an interest on the amount deposited by the investor. While bank accounts are often considered among the least risky investment options, they also offer correspondingly low returns on investment.
Do note that there can be many different types of bank accounts. Savings bank accounts provide us with ready cash – we can withdraw our money from these accounts without giving prior notice (and with few limitations). These accounts provide relatively low returns. Term deposit accounts have fixed periods of maturity and often do not allow investors to withdraw their funds before the completion of the period of maturity. In some cases, they may allow early withdrawal of funds but may levy certain penalties for the same. Term deposit accounts typically offer higher rates of interest than savings accounts. Do note that some term deposit accounts may have maturity periods of up to 5 years.
These are essentially very similar to bank accounts. However, instead of depositing your money with a bank, you need to deposit it with a non-banking firm. Such deposits generally have fixed periods of maturity and cannot be withdrawn before maturity. These deposits may offer somewhat higher returns than some bank accounts.
Money Market Securities
These securities are another type of lending-based instruments. These securities can be issued by governments, by various banks, by some non-banking financial institutions, and also by large corporate entities. The most important feature of money market securities is that they provide a lot of security. Hence, they are a very good investment option for safeguarding one’s capital. These instruments can also be traded very easily and quickly on various markets dedicated specifically to such instruments. Thus, these securities also provide a lot of liquidity. However, these instruments typically offer very low rates of return.
Short Term Bonds
Bonds are another type of common lending instrument. Purchasing a bond is equivalent to lending a certain sum of money to the issuer of the bond. Bonds have predetermined rates of maturity and offer a certain rate of interest to investors. Bonds can be issued by the government of a country or by local government bodies or by corporate entities.
Bonds can have a lot of variety – some bonds may be highly secure and may offer relatively low returns while others may have very little security (and may have high default risk) but may offer very high rates of return (even up to 50% a year). Similarly, some bonds may mature after just a few years while many common bonds may have periods of maturity of up to 30 years. Do note that short term bonds would typically offer lower returns than long term bonds. Some bonds can also be traded on various exchanges. Thus, bonds offer a lot of variety and hence, are very popular investment instruments. Hence, many investors ensure that they do allocate at least some part of their funds to bonds.
Bond funds (including short term funds) offer another popular approach to investing in bonds. Such funds invest in a mix of bonds or, in many cases, in a mix of bonds and other instruments. These funds are professionally managed and hence, they make it easier for investors to enter the bond market. Investors that use such funds need not decide which individual bonds they wish to invest in – that decision would be taken by the fund managers. Hence, bond funds are very attractive for many investors.
Many investors buy shares of various companies with the intention of selling off those shares within one to three years. Hence, investing in the share market can also be a short term investment for many investors. Do note, however, that experts typically recommend that share market investments must be made with an investment horizon of at least between 5 to 10 years. It is suggested that such a long investment horizon is needed in order to maximize one’s chances of getting good returns in the share market. In the short term, even a well-managed company may underperform and hence, may not yield good returns in a short timeframe.
These are the most popular (most commonly used) short term investment options. As we have seen, many of these options offer high security along with some returns. Thus, a mix of these instruments can provide good capital protection as well as liquidity and returns over a short timeframe. Now that you know about these options, you may include some of them in your investment portfolio and benefit from them.