Short-Term Investments: Definition, How They Work, and Examples

What Are Short-Term Investments?

Short-term investments, also known as marketable securities or temporary investments, are financial investments that can easily be converted to cash, typically within five years. Many short-term investments are sold or converted to cash after a period of only three-12 months. Some common examples of short-term investments include CDs, money market accounts, high-yield savings accounts, government bonds, and Treasury bills. Usually, these investments are high-quality and highly liquid assets or investment vehicles.

Short-term investments may also refer specifically to financial assets—of a similar kind, but with a few additional requirements—that are owned by a company. Recorded in a separate account, and listed in the current assets section of the corporate balance sheet, short-term investments in this context are investments that a company has made that are expected to be converted into cash within one year.

Short-term investments can be contrasted with long-term investments.

Key Takeaways

  • Short-term investments, also known as marketable securities or temporary investments, are financial investments that can easily be converted to cash, typically within 5 years.
  • Short-term investments can also refer to the holdings a company owns but intends to sell within a year.
  • Common examples of short-term investments include CDs, money market accounts, high-yield savings accounts, government bonds, and Treasury bills.
  • Although short-term investments typically offer lower rates of return, they are highly liquid and give investors the flexibility to withdraw money quickly, if needed.
  • Any increases or decreases in the value of a company's short-term investments are directly reflected on a company's income statement for the quarter.
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Short-Term Investments

How Short-Term Investments Work

The goal of a short-term investment—for both companies and individual or institutional investors—is to protect capital while also generating a return similar to a Treasury bill index fund or another similar benchmark.

Companies in a strong cash position will have a short-term investments account on their balance sheet. As a result, the company can afford to invest excess cash in stocks, bonds, or cash equivalents to earn higher interest than what would be earned from a normal savings account.

There are two basic requirements for a company to classify an investment as short-term. First, it must be liquid, like a stock listed on a major exchange that trades frequently or U.S. Treasury bonds. Second, the management must intend to sell the security within a relatively short period, such as 12 months. Marketable debt securities, aka "short-term paper," that mature within a year or less, such as U.S. Treasury bills and commercial paper, also count as short-term investments.

Marketable equity securities include investments in common and preferred stock. Marketable debt securities can include corporate bonds—that is, bonds issued by another company—but they also need to have short maturity dates and should be actively traded to be considered liquid.

Short-Term Investments vs. Long-Term Investments

Unlike long-term investments, which are designed to be bought and held for a period of at least a year, short-term investments are bought knowing they will be quickly sold. Typically, long-term investors are willing to accept a higher level of volatility or risk, with the idea that these "bumps" will eventually smooth out over a long period—as long as, of course, the investment is growing in a positive trajectory

Long-term investments are also used by individuals that are able to stow away their money and don't have immediate needs for it (such as to buy a car or a house).

Advantages and Disadvantages of Short-Term Investments

Short-term investments help ground an investor's portfolio. Although they typically offer lower rates of return compared to investing in an index fund over time, they are highly liquid investments that give investors the flexibility of making money they can withdraw quickly, if needed.

For a business, long-term investments are not counted as income until they are sold. This means that companies that decide to hold or invest in short-term investments count any fluctuations in price at the market rate. This means short-term investments that decline in value are marked down as a loss for the company on the income statement.

Pros
  • Short-term investment gains are reflected directly on the income statement.

  • Short-term investments take on lower risk, making them stable options.

  • Short-term investments help diversify income types, in case of market volatility.

Cons
  • Short-term investments typically have lower rates of return.

  • Any declines in value of a short-term investment will directly affect the net income of a business.

Examples of Short-Term Investments

Some common short-term investments and strategies used by corporations and individual investors include:

  • Certificates of deposit¡ (CDs): These deposits are offered by banks and typically pay a higher interest rate because they lock up cash for a given period. These periods usually range from several months up to five years. They are FDIC-insured for up to $250,000.
  • Money market accounts: Returns on these FDIC-insured accounts will beat those on savings accounts, but require a minimum investment. Keep in mind that money market accounts differ from money market mutual funds, which are not FDIC-insured.
  • Treasuries: There are a variety of these government-issued bonds, such as notes, bills, floating-rate notes, and Treasury Inflation-Protected Securities (TIPS).
  • Bond funds: Offered by professional asset managers/investment companies, these funds are better for a shorter time frame and can offer better-than-average returns for the risk. Just be aware of the fees.
  • Municipal bonds: These bonds, issued by local, state, or non-federal government agencies, can offer higher yields and tax advantages since they are often exempt from income taxes.
  • Peer-to-peer (P2P) lending: Excess cash can be put into play via one of these lending platforms that match borrowers to lenders.
  • Roth IRAs: For individuals, these vehicles can offer flexibility and a variety of investment options. Contributions, but not gains, to Roth IRAs can be withdrawn at any time, without penalty or taxes due.

If you have excess cash, using it to pay off higher-interest debt may be more advantageous than investing it in low-risk but low-return short-term investments.

Real-World Example of Short-Term Investments

On its quarterly statement dated Apr. 21, 2022, Microsoft Corp. reported holding $92.2 billion of short-term investments on its balance sheet. The biggest component was U.S. government securities, which was $78.4 billion. This was followed by corporate notes/bonds worth $11.7 billion, mortgage/asset-backed securities at $590 million, foreign government bonds worth $501 million, municipal securities at $269 million, and certificates of deposit (CDs) at $2 billion.

What Are the Best Short-Term Investments?

Some of the best short-term investment options include short-dated CDs, money market accounts, high-yield savings accounts, government bonds, and Treasury bills. Check their current interest rates or rates of return to discover which is best for you.

Where Can I Invest for 6 Months?

Common short-term investment vehicles include six-month CDs, money market accounts, high-yield savings accounts, government bonds, and Treasury bills.

What Is the Best Way to Invest $5,000?

Based on experience and risk tolerance, investors will differ on this question. However, many financial analysts will say the best way to invest $5,000 is to put it in a mutual fund or exchange-traded fund that tracks the S&P 500 and keep it for the long run.

What Can You Invest in With Little Money?

Individuals with only a little bit of cash have a lot of options. They can put the money in any investments that don't require a minimum balance, such as certain savings accounts, fractional shares of an index fund, or even cheaper stocks, bonds, and CDs.

The Bottom Line

Short-term investments can be great investments for individual investors and corporations who are looking for both liquid and stable options to grow their wealth. The options are plenty: from CDs to bonds and high-yield savings accounts, it's only up to each investor to do their homework.

Article Sources
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