Conventional wisdom says you should leave your money in a savings account if you intend to use it in the next three to five years. The problem is that these accounts often have low interest rates that don't keep pace with inflation, so your money loses value over time.
Investing is a good way to grow your money, but when you're investing for the short term, you want to avoid anything too risky, or else you could lose money. Here are five low-risk places to invest your money for a few years.
1. High-yield savings accounts
High-yield savings accounts are available through many online banks. They can afford to pay higher interest rates than brick-and-mortar banks because they have lower operating costs. Some high-yield savings accounts pay upwards of 2% APY. This stands for "annual percentage yield," which is the amount of interest your money will earn every year it remains in the savings account.
Many high-yield savings accounts offer over 20 times the national savings account average of 0.09% APY. To show you the difference this makes, consider a $1,000 savings account deposit. In a year, you'd have $1,000.90 if the account has a 0.09% APY. But a 2% APY would leave you with about $1,020 after a year.
When choosing a high-yield savings account, make sure it is FDIC-insured. This insurance will reimburse you up to $250,000 in the unlikely even that the bank fails. You should also look into the account's required minimum balance, monthly service fees, and any limitations on transactions to make sure you're comfortable with them.
It may take a few days to get your money out of a high-yield savings account when you need it. You may need to request a check or a transfer to another bank where you can withdraw the money in person unless you can access the money through an ATM. You can always pay for a wire transfer if you need the money quickly.
2. Certificates of deposit (CDs)
With a certificate of deposit (CD), you put money in a bank account and agree not to touch it for a set period. Terms can range from a couple of months to 10 years. In exchange for not touching the money, the bank offers you a higher interest rate than the 0.09% APY you would get with a traditional savings account. Generally, the longer the term of the CD, the higher the interest rate will be. Some pay over 3% APY.
You can withdraw money from a CD before the maturity date, but you will pay a penalty for doing so. The fee is usually several months' interest, though it depends on how early you withdraw the funds. You may only pay one month's interest on money withdrawn within three months of the maturity date. But you could pay 12 months' interest if you withdraw more than two years before the CD matures. For this reason, CDs are only a good choice if you feel confident that you won't need the money before its maturity date.
3. Short-term bond funds
A short-term bond fund is a mutual fund that owns bonds with maturity terms that are usually five years or less. A bond is a loan that you're giving to the company or other entity whose bond you're buying. It will pay you back the full amount of the bond plus interest by the maturity date. Short-term bond funds' average annual return can vary from less than 1% to over 3%, according to Morningstar data.
Bonds are considered less risky than stocks, but that doesn't mean they're risk-free. If inflation rises sharply, your bond fund is locked in at a lower interest rate, so your money will not appreciate in value. But unlike a CD, you can take your money out of a short-term bond fund before its maturity date without penalty.
Be mindful of the fund's expense ratio. All mutual funds charge an expense ratio -- an annual fee -- to shareholders, and this can eat into your profits. You can find this information in the fund's prospectus. Ideally, you shouldn't pay more than 1% of your assets in fees each year.
If you're concerned about inflation ruining the value of short-term bond funds, an I-bond may be more your style. These bonds are backed by the U.S. Treasury and guaranteed to keep pace with inflation. The rate for I-bonds issued between November 2018 and April 2019 is 2.83% for the first six months. The rate is adjusted every six months thereafter to ensure it keeps up with inflation.
You can cash in an I-bond after one year, but if you cash out before five years, you will pay a fee equivalent to three months' interest. After five years, there is no penalty. It's worth noting that the Treasury limits individuals to a maximum of $10,000 in I-bonds, so you may need to couple this with another strategy if you plan to invest more money than this.
5. Peer-to-peer lending
Peer-to-peer lending sites enable you to lend money to borrowers just like a bank. But rather than investing all your money into a single loan, you invest small amounts in multiple loans to lower your risk of loss. Borrowers pay back what they owe you plus interest, usually over three to five years. But there's a significant chance that they could default and you will not get your money back.
Depending on how much you invest and the credit scores of the borrowers you invest in, it's possible to earn anywhere from 4% to 7% APY as a peer-to-peer lender. Borrowers with poor credit pay higher interest rates, but there's also a greater risk of them defaulting, so it's not a good idea to put all of your money in these high-risk loans.
There's no way to get your money out early with peer-to-peer lending, so don't try it unless you know you won't need the money for a few years. You will also need a couple thousand dollars to start with if you want to be well diversified, so it's not a good fit for those looking to invest smaller amounts.
Investing for the short term is more about making sure you don't lose money than it is about chasing big returns. The five options listed above are good places to begin. Choose one or divide your money across a few if that suits you better.