Short Term Investments Definition
Short term investments refer to spending on high-quality investment vehicles that can be converted into cash as early as one day. As a highly liquid option, these allow investors to enjoy the interest benefits over time. In addition, the returns obtained on these investments help individuals meet their short term financial requirements without much struggle.
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Also known as temporary investments, these could be converted into cash in one day to within five years. Such investment options differ from their long-term counterparts, where investors have to wait too long for the investments to mature.
Table of contents
Key Takeaways
- Short term investments are investments that mature in a day to a few months and help to serve the immediate financial requirements.
- At maturity, these temporary investments get converted into cash easily or become saleable in within a year.
- Some of the best temporary investment options include Certificates of Deposits (CDs), short term mutual funds, commercial papers, government treasury bonds, money market accounts, etc.
- A temporary investment may turn into a long term investment if the assets are held for longer than decided.
Short Term Investments Explained
Short term investments are classified based on two criteria – these vehicles mature in a couple of months or a few years and become saleable within a year. Therefore, any investment that fulfills these two requirements is categorized as a short-term financial investment option.
Businesses and organizations opt for such temporary investments to ensure they have enough cash to invest in other assets to grow their ventures. For example, the companies that remain in a strong financial position always aspire to retain and even move beyond what they have achieved. Investing in short-term options lets them have additional cash to spend on stocks and bonds, keeping the company’s revenue or profit shares untouched.
Individuals look forward to investing in temporary options when they have frequent short term financial obligations to fulfill. However, when individuals and businesses invest in such financial options, they get a chance to enjoy the benefits of higher interest rates over a period. They make an investment, which they convert into cash or sell in a few months, reaping profits, and then repeat the process, thereby grabbing short-term profits now and then.
Short term investments on the balance sheet find a place in the current asset section.
Short Term Investment Options
When it comes to investing for the short term, there are many short term investments options available for investors. Some of them are:
Certificates of Deposit (CDs)
Certificates of DepositsCertificates of DepositsA certificate of deposit (CD) is an investment instrument mostly issued by banks, requiring investors to lock in funds for a fixed term to earn high returns. CDs essentially require investors to set aside their savings and leave them untouched for a fixed period.read more (CDs) mature as early as three months and can extend up to seven years. The longer the tenure, the higher the interest rate and vice versa. Investment vehicles can be obtained from banks and are considered one of the most reliable and safest temporary investment options.
The interest rate offered for CDs is far better than other short term financial investment options, given the cash is kept locked for a set time. Moreover, these alternatives are backed by the Federal Deposit Insurance Corporation (FDIC).
Short Term Mutual Funds
Mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more can be short term as well as long-term. Based on what can be called a short term option, one needs to select the right deal. Individuals also have an overnight mutual fund option, which matures on a daily basis.
The returns received depend on the performance of the fund managersFund ManagersA fund manager refers to an investment professional responsible for fund investment strategy formulation and implementation. They collect and invest the money from various investors and create a good variety of managed funds catering to the diverse preferences exhibited by the investors. read more of the equity marketEquity MarketAn equity market is a platform that enables the companies to issue their securities to the investors; it also facilitates the further exchange of these stocks between the buyers and sellers. It comprises various stock exchanges like New York Stock Exchange (NYSE).read more. Therefore, it is recommended that the investors choose an open-ended fund to ensure they are allowed to sell the units as and when desired. On the other hand, if a close-ended fund is selected, the opening and closing dates are determined by the mutual fund company, restricting the investors’ right to sell assets in short-terms.
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Money Market Account
It is the short term investing alternative that tends to yield much better returns than savings accounts. Like the CDs, these are also FDIC-insured accounts having specific investment requirements. The insurance offered keeps investors’ amounts protected.
Having this account helps individuals issue checks, and they can use debit cards for various transactions. However, it allows only a limited volume of monthly transactions.
Peer-to-Peer Lending
Also known as P2P lending, it marks the investment option offered to both borrowers and lenders. People with excess cash can help finance seekers and offer them the required amount with a lenient interest applied.
Such lending practices find relevance for both personal and business purposes. An online broker can help match borrowers with lenders for P2P lending to happen. At the time of repayment, the investor or lender gets the principal amount plus the interest as the total return.
Treasury Bonds
These government-issued treasuries help authorities meet their short term financial requirements. These are backed by government securities and are safe to invest in. However, it needs slightly higher skillsets as buying and selling securities to need a basic understanding of the investments. Treasury bonds can be issued by the Central Government, State Government, or local municipal bodies.
Commercial Papers
The privately held companies issue papers to serve their short term financial purposes, just like the government issues treasury bonds. Interest rates on commercial papersCommercial PapersCommercial Paper is a money market instrument that is used to obtain short-term funding and is often issued by investment-grade banks and corporations in the form of a promissory note.read more are slightly higher than the government-backed treasuries.
Commercial papers are easy to invest in and less risky against defaults. Companies obtain them to pay for the inventories and finance their payrollsPayrollsPayroll refers to the overall compensation payable by any organization to its employees on a certain date for a specific period of services they have provided in the entity. This total net pay comprises salary, wages, bonus, commission, deduction, perquisites, and other benefits.read more.
Examples
Let us consider the following short term investments examples to understand the concept better:
Example 1
Allen required funds to pay off his debtDebtDebt is the practice of borrowing a tangible item, primarily money by an individual, business, or government, from another person, financial institution, or state.read more worth $5,000 in the next five months. Though he had good earningsEarningsEarnings are usually defined as the net income of the company obtained after reducing the cost of sales, operating expenses, interest, and taxes from all the sales revenue for a specific time period. In the case of an individual, it comprises wages or salaries or other payments.read more, his household requirements hardly allowed him to use that amount from his monthly income. As a result, he invested in the CDs to mature in the next three months. At the end of the tenure, the investor received $7,000, of which he paid the amount and added the remaining $2,000 in meeting other additional household needs.
This is how such options work and help individuals.
Example 2
Suppose Company A decides to invest in Amazon shares as a short term investing alternative. After three months, it plans to finance the payroll, including incentives with this money. However, when converting the assets into cash by selling the securities, the market declines and the management decides to hold on to the assets for a few more years until the market stabilizes and the prices go up as expected.
In this scenario, though company A made an investment for short term, its decision to keep the shares for a longer span of a few years converts this temporary investment into a long-term investment.
Short Term Investments vs Long Term Investments
It might be easy to distinguish between short term and long term investments. However, there are a few points to help investors decide which would be better for them at what time:
- Short term investing options mature early, whereas long-term alternatives take many years to mature and yield returns.
- The temporary investment option is the best fit for those who require immediate finance leads. On the other hand, long term investments are meant for long term plans.
- When one opts for the short term option of investing, it is less likely for the market volatility to affect the investment as it matures and gets ready for withdrawal in days or months. On the contrary, long term investments are highly volatile as they are invested for a longer time.
Frequently Asked Questions (FAQs)
It is an option whereby investors expect the assets to be converted into cash in as early as a day. This highly liquid nature makes the assets one of the best ways of serving an immediate financial need, be it for an individual or a business.
Yes, it is recorded as a current asset. This is because it promises significant returns in a very short period, which helps businesses or individuals to fulfill their short term requirements without much struggle.
Yes, such investments are marketable securities. These temporary investing options allow investors to sell the involved assets and securities within a year. Hence, they can trade them as and when desired.
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