Generally speaking, investing is a long-term process. You invest in your IRA and your 401 (k) to achieve a long-term goal: retirement. You can invest in a 529 Education Savings Plan for many years to achieve another long-term goal – college for your kids. But is there also a place in your portfolio for shorter-term investments?
In short, yes. You have three good reasons for holding short-term investments: liquidity, diversification, and longer-term investment protection. Let’s look at the three:
- Liquidity – For many people, the COVID-19 pandemic has highlighted the need for easy access to cash, and short-term investment vehicles are typicalliquid ment. Still, some are more liquid than others, and you’ll want to know the differences early on.
The most liquid vehicle you can have is probably not an investment at all, but rather a simple savings or checking account. But you could probably earn a lot more interest with a high yield online savings account without sacrificing a lot, if any, in liquidity. Money market accounts are also very liquid, but they may have minimum balance requirements.
Other short-term investments may be less liquid, but that may not be a major concern if you don’t need the money immediately. For example, you could buy a type of mutual fund known as a super short-term bond fund that invests in longer-term bonds maturing in less than a year, so you can benefit higher interest rates generally offered by these bonds. You can choose to partially or fully liquidate your bond fund at any time, but the sale can take several days as the fund’s shares need to be sold. You can also invest in a three certificate of deposit (CD), but if you cash it earlier, you will lose part of the interest payments.
- Diversification – If your portfolio is made up largely of stocks, ETFs and equity-based mutual funds, you could take a hit, at least temporarily, during times of declining markets, which are part of the of the investment world. But a diversified portfolio, containing both long and short term investments, can better withstand periods of market volatility. This is because the short-term vehicles we looked at will generally be much less affected by market movements, if at all. (Keep in mind, however, that diversification by itself cannot guarantee profits or protect against all losses.)
- Long-Term Investment Protection – If you had to meet an unexpected expense, like needing a major home or car repair, how would you pay for it? Without any cash reserves, you might be forced to dip into your long-term investments, such as your 401 (k) and your IRA. But in doing so, you might have to pay taxes and penalties and, perhaps even more important, you would be drawing resources from accounts designed to help you enjoy a comfortable retirement. With enough short-term investments in place, however, you can avoid hitting these long-term accounts. As you can see, you can benefit significantly by adding short term investment vehicles to your portfolio. They could make a big difference in your ability to reach your financial goals.