When you are trying to save money to go on a trip, pay for college or some other short-term expense, you have to weigh the desire for returns with the need to protect your principal. You can invest your money for just a year in a variety of ways and enjoy a decent return without taking any undue risks.
Certificates of Deposit
Most banks offer certificates of deposits with 12-month terms so you can invest your money in a CD for exactly one year without having to worry about monitoring the account. CDs pay a fixed rate of interest so you can calculate exactly how much interest your account will earn. Banks occasionally have special promotions for CDs, which means that you can earn higher than normal rates. Shop around for the best rate; credit unions are not-for-profit entities and usually have better CD rates than banks, but you must meet eligibility requirements to join.
Bank money market accounts, unlike CDs, are highly liquid, which means you can access your funds at any time. Interest rates on money markets are not as high as on CDs, but the liquidity means money markets are designed for people who are unclear as to exactly when they will need to have access to their funds. Money market mutual funds work similarly to money market savings accounts in so far as you earn interest and you can access your funds at any time. However, money market funds, while ultra conservative, have no principal protection. You could lose money. CDs and bank money markets are both federally insured.
The federal government issues short-term debt instruments called Treasury bills that have term times lasting between four weeks and one year. You buy Treasury bills at a discount to the face value and receive the face value at maturity. Interest rates are low when compared with CDs, but you can split your money up across bills with different term times and cash in your bills as and when you need your money rather than having all of you money invested in one account. You normally need to invest at least $5,000 to get the best rate on a CD, but you can buy Treasury bills with just $100.
Mutual funds expose you to principal risk, but you can buy bond funds that contain short-term municipal bonds that are relatively stable when compared with other kinds of funds. Municipal bond funds pay tax-free interest, whereas earnings on CDs and money markets are subject to state and federal income tax. Your shares may also rise in value so you can make money both in terms of interest and capital gains.
You can buy various different types of mutual funds and in many instances you have to pay a commission when you buy or when you sell the shares. However, Class C shares are mutual fund shares on which you pay no upfront or back-end commission as long as you hold onto your shares for one year. Dividends paid on Class C shares are not as high as on other kinds of shares but are still higher than on other kinds of short-term investments. However, only buy mutual funds if you can afford to take some risks with your money.