Original Link | Investopedia
An issue that has come up frequently the last several years is when people have money in savings that they don’t need right now but they need it in a year or two for some specific goal like a vacation or a down payment on a house. Savings accounts are paying less than one percent so people want an alternative with a higher interest rate but want a stable return.
Sometimes people ask if they should invest it in the stock market so they can get a better return. If you need the money within five years, don’t invest it in the stock market, save it in more conservative fixed rate investments. The reason I say that is because in five years or less your money invested in the stock market could be worth less than you initially invested by the time you are ready to use it. There is no magic to the five-year recommendation, but historically the market has had positive returns 87% of the time over five-year periods. Even five years is no guarantee your investment will be worth more than you originally invested, but once you get to five years the probability that you’ll have a positive return is pretty good. The last thing you want when saving money for a short-term goal is to have a return that fluctuates and goes negative.
Where to Invest Money for Less Than Five Years
So if you’re trying to do better than a savings account but don’t want the risk of the market, where do you go? Here are three suggestions.
Online savings accounts. Savings accounts or money market accounts that you open online often pay more interest than those of the bank in your neighborhood. All you need to do is Google a term like “online savings account” and you’ll get all the information you need to see what’s available. Rates are ranging from 1.15% to 1.25%, most with no minimum balance required. You won’t be able to go to the drive-thru window and make a withdrawal when you need your money, but you can request the money electronically and have it deposited in your checking account within a few days. (For related reading, see: Banks That Pay the Highest Interest Rates on Savings Accounts.)
CDs. My recent search online shows rates from 1.40% for a one-year CD to 2.25% for a five-year CD. In return for the higher rates you give up a little bit of flexibility in that you have to leave the money deposited for the period of the CD or be subject to penalties if you withdraw it early. But if you’re sure you won’t need the money during that time period, a CD could be a good solution.
Short-term bond funds. Unlike savings accounts or CDs, short-term bond funds do not guarantee an interest rate. Because of that they are a little riskier. You may get a little higher return than a savings account or CD, but it may be lower too. Because these investments can fluctuate, you don’t know ahead of time. With that being said, they are still conservative investments. If you want absolutely no fluctuation in return, then one of the other options is better suited for you.
While the low interest rate environment we’re in can be great for those borrowing money since they are able to borrow at lower interest rates, it can be tough for savers trying to earn decent interest on their short-term investments. The suggestions above should help you earn a little more than you can get at the bank. (For related reading, see: Best Strategy for Short-Term Savings Goals.)