Generally speaking, there are investments that make sense for short-term investors and others that are more sensible for those with a longer time horizon. Some investments are better for people with a low tolerance for risk (online savings or money market accounts), while others may be a good fit for investors who don’t mind some volatility as long as the potential gains are larger. Before you look at the investment options, it’s important to understand the types of accounts that you can hold your investments in. Longer-term investments should be placed in tax-advantaged retirement accounts, such as a 401(k) plan, a traditional IRA, or a Roth IRA. These accounts are ideal for funds that you don’t plan on tapping until you stop working. If you need your money sooner, you can invest using a taxable brokerage account. Just be aware of the possible capital gains and other taxes you might have to pay. Let’s examine some of the most common investments out there, identifying whether they are appropriate for short-, intermediate-, or long-term investing. We’ll also look at some pros and cons and their potential annual returns.
Short-Term (Less Than 3 Years)
Online savings or money market account
LiquidFDIC-insuredPotential return: 0.0-1 percent
Short-Term CDs
Not liquid, but you can get short-term CDs that tie up your money for only one month at many banks. FDIC-insured Potential return: 0.0-1 percent
Intermediate Term (3-10 years)
Longer-Term CDs
Not liquid FDIC-insured Longer terms of as long as 60 months can come with higher interest rates. Potential return: 0.5-2 percent
Short-Term Bonds and Funds
Not liquidNot FDIC-insuredPotential return: 0.0-1 percent
Peer-to-Peer Loans
Loan recipients may fail to pay you back.Not liquidPotential return: 4-5%
Low-Volatility Stocks and Equity Funds
Not FDIC-insured Dividends could be a source of income. Potential return: 6% or more
Long-Term (Beyond 10 years)
Individual Stocks
Highest risk Liquidity may be an issue. Potential return: Varies
Equity Index Funds and Exchange-Traded Funds
Broad diversification potentialMay have minimum investment requirementsPotential return: 10%
Actively Managed Stock Funds
Potential for market outperformance or underperformanceHigher costs than index fundsMay have minimum investment requirementsPotential return: 10%
Long-Term Bonds and Bond Funds
Less risky than stocksMay require a sizable minimum investmentPotential return: 6%
Robo-Advisors
A hands-off approachTax loss harvesting and rebalancingMay require a high minimum investmentPotential return: Varies
Investments for the Short-Term (3 Years or Less)
Online Savings or Money Market Account
If you think you’ll need your money within a few years, the safest place to put it is in the bank. These days, there are many online-only savings accounts that offer interest rates higher than most brick-and-mortar banks. Money market accounts offer similar income. These days, interest rates are still quite low, so you may only make up to 1 percent annual return. But all of your money is FDIC-insured up to $250,000 and you can withdraw at any time without paying penalties.
Short-Term CDs
If you are willing to have your money locked up for a short time, a certificate of deposit might make sense for you. With a CD, you agree to keep your money in the bank for a specified length of time in exchange for a higher interest rate. Generally, you will make more money if you keep your money longer and have a higher balance. It’s possible to find CD terms as short as 1 month. With CDs, you lose some flexibility but may be able to get interests rates up to 1 percent.
Investments for the Intermediate Term (3-10 Years)
Longer Term CDs
CD interest rates generally rise based on the length of the term. So if you are willing to keep money in a CD for 3, 4, or even 5 years, you may see a decent return between 0.5 to 2 percent. It’s income you can count on, and all CD funds are usually FDIC-insured. Rates may be highest if you can afford to make a sizable deposit. To maintain flexibility, many investors will set up “CD ladders” with sums of money invested in CDs with various term lengths.
Short-Term Bonds and Funds
It’s easy to make money off corporate and government debt. By purchasing bonds, you are essentially lending money for a specific term in exchange for periodic interest payments. There is some risk to bond investing—riskier bonds usually pay higher rates—but there are many bonds that are practically a sure thing. Take a look at U.S. Treasury bonds with 1- or 2-year terms, or high-rated corporate bonds that offer up to a 1 percent return. If you are intimidated by the idea of buying individual bonds, you can get bond funds or exchange-traded funds that expose you to a broad range of bond investments.
Peer-to-Peer Loans
Peer-to-peer lending is like bond investing, in the sense that you are essentially buying debt in exchange for a return. But in the case of P2P lending, you’re lending money to an individual. (It may be a person who needs an auto loan, or a loan to pay off credit card debt, for example.) P2P lending has taken off as an investment thanks to online platforms such as LendingClub. It’s possible to create whole “portfolios” of loans with various risk levels. While P2P lending comes with the risk that loans will default, a sensible and diversified strategy can usually result in positive returns. Historical annual returns from LendingClub 4.85 percent for the safest loans to 6.4 percent from riskier loans.
Low Volatility Stocks and Index Funds
It’s generally best to avoid putting your money in stocks unless you have a long-term strategy. Stocks can go down in value quickly and may often take years to recover. That said, there are certain kinds of equities that might make sense for an investor with a time horizon between five and 10 years. Look for stocks that maintain relatively stable share prices through good and bad times. Utility stocks (such as the electric company) are among the least volatile stocks, and you can also look to companies that tend to perform well in both good and bad markets (Walmart comes to mind.) To spread out risk, look at broad-based mutual funds and exchange-traded funds that are designed to be less volatile. These investments may result in losses but could generate good profits if the market does well. Stocks should not comprise the bulk of a person’s investment portfolio if they are investing in the intermediate term. But the right types of equities can be beneficial as one slice of the pie.
Investments for the Long-Term (Beyond 10 years)
Individual Stocks
With an investment time horizon beyond 10 years, most investors can expand their risk tolerance and invest in stocks. Historically, investing in the S&P 500 will result in an average annual return topping 7 percent. You may see larger or smaller returns based on the stocks you choose. The smartest approach to individual stock investing is to focus on large, diversified companies that have shown a consistent track record of increasing earnings and profits over time. You will undoubtedly see down years, but if you are saving for a long-term goal such as retirement, you will be giving the stocks time to rebound and earn you money.
Index Funds and ETFs
Why do the work of picking individual stocks, when you can simply invest in the entire stock market or sector of the market at once? These days, there are a plethora of mutual funds and exchange-traded funds that are designed to mirror the performance of the S&P 500 or other indexes such as the Russell 2000 and even international markets. They are usually passively managed and have low expenses, and are an easy way to build a diversified portfolio. There’s very little difference between exchange-traded funds and mutual funds, except that exchange-traded funds trade like stocks and usually don’t require minimum investments.
Actively Managed Funds and ETFs
If you want to generate returns that are better than index funds over time, you may choose to turn to mutual funds and exchange-traded funds that are actively managed. This means a fund manager personally selects the stocks to go into a fund and attempts to generate higher returns than the benchmark. So for example, a fund manager in charge of a broad U.S. equities fund will attempt to generate a higher return than the S&P 500. Actively managed funds have higher expense ratios than index funds, and there has been a long debate about whether actively managed funds are worth the extra costs. It’s impossible to know in advance whether a mutual fund will “beat the market” over the long term, but some funds and fund managers have better track records than others.
Long-Term Bonds and Bond Funds
Investors with a long time horizon don’t need a lot of bonds in their portfolio, but it doesn’t hurt to have some included just to balance out risk. It’s possible to invest in a large swath of corporate, U.S. government, and municipal bonds using a broad bond mutual fund. There are also global bond funds that give you access to the fixed income markets in other countries.
Robo-Advisors
One of the newest innovations in investing is the robo-advisor. There are several types of robo-advisors with different capabilities and approaches, but the general concept is that you hand over control of your portfolio to a company that manages it according to your investing goals and risk tolerances. Personal Capital and Betterment are two robo-advisors that have jumped onto the scene in recent years, and many traditional brokerages including Charles Schwab and Vanguard now offer robo-advisor services. Robo-advisors are only found online and will manage your investments in an automated way using algorithms and advanced software. The robo-advisor will take care of security selection and perform rebalancing and even tax loss harvesting. Many robo-advisors will allow you to open accounts and get started quickly, and fees are usually quite low compared to a human financial advisor.
