The Advantages of Short-Term Investments

You invest for your future, whether it's your dream home, your child's education, or your retirement. Each of these events occurs at different times in your life and as a result need to be planned within certain time frames. A short-term investment strategy within a well-diversified, long-term investment plan is the key to dealing with your financial needs as they occur.

"Short-term" can mean anything from several months to several years. Investors use a general rule of thumb of three years, and anything under that is considered a short-term investment. Short-term investments have either low yields or high risks, depending on where you put your money, but are important as a way of making more profit from your cash savings or liquid assets.

Whether it's setting up a savings fund for next Christmas, accruing the down payment on a home that you hope to buy in the next year or two, or putting the money together for a franchise business, short-term investments are about making the most of your money in a small amount of time with the least amount of risk and penalties. Short-term investments can be turned into cash or rolled over into other short-term or long-term investments.

Within your investment portfolio, short-term investments protect your long-term investments. Stocks and real estate have a high yield, particularly if you keep them for a long period of time. The problem arises when you have a financial emergency where you need cash right away. Without a buffer of some sort, you are forced to liquidate your long-term investments, sometimes at a loss.

The solution is to keep short-term investments that are easy to liquidate in case of an emergency. Cash is the best buffer but offers no interest. A savings account is a little better, but still the interest is low. Short-term investments offer a way of increasing your profit on assets that you need to remain more liquid as a hedge against future problems.

You need to plan your investments in accordance with the events in your life. Different events happen at different times and need to be planned for accordingly. In your financial plan, map out what you need and when you will need it. Questions you should ask yourself include the following:

• What are my financial goals?
• How much money do I have to invest?
• How long can I wait until I need the money?
• How much flexibility do I have with this time frame?
• Can I afford to lose any of my investment?

The main pitfalls of short-term investing are high risk and low yield. If you invest short-term in stocks, you are taking a high risk with your investment money because of the cyclical nature of most stocks. Another problem is tax consequences of investment made for less than a year.

Because most investors have no desire to lose their investment money, they opt for safer short-term investments in the form of treasury bills (T-Bills), certificates of deposit (CDs), and money market funds. T-Bills and CDs have fixed interest rates and maturity times. The disadvantage that fixed investments have is that you are penalized if you take the money out before the maturity date.

Investment professionals advise investing your short-term money in money market mutual funds. Their yield can be lower than fixed investments, but the advantage is that you can generally access the money when you need it. This advantage makes money market funds a great way to protect your long-term investments by providing you with ready cash in case of emergencies.