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Short-term investment: What is that actually?

Short-term investment: What is that actually?

FINEXITY
4 minutes 
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November 7, 2024

Overnight money, fixed-term deposits, stocks, bonds, ETFs or funds are likely to be familiar to most investors. But what about “short-run investments”? As the name suggests, this subcategory of investment is suitable for investors who do not want to commit themselves for a long time. Find out when short-run investments are an option, what forms there are and what investors should consider.

What are short term investments?

A The central feature of short-run investments is the manageable duration, which is primarily between three and 24 months. These investments therefore offer good liquidity and are considered to be less risky compared to long-term investments, as the expected return is often also known in advance. Short-term investments can therefore be a flexible and secure way to invest capital in the short term and achieve an attractive return in the process.

These types of short term investments exist

There are various forms of short-run investments, which differ in terms of return, risk and duration. For example:

  • Short-term bonds: Government or corporate bonds with a term of up to two years are a popular form of short-run investment. They often offer a fixed interest rate and are considered relatively safe, particularly when it comes to government bonds.
  • Money market funds: These funds invest in short-term debt instruments, such as government bonds or short-term corporate bonds. They offer flexibility, as the invested capital can be retrieved at any time.

Challenge: investment 2024

However, short-term investments are not suitable for every market phase. As a result, the environment for investors this year and probably next year is quite challenging. Falling inflation rates and a worsening of economic sentiment make further Key interest rate cuts in the Eurozone are increasingly likely. Experts currently assume that the ECB will take two more interest rate steps by the end of the year to mitigate recession risks and continue the trend in 2025. This means that forms of investment such as fixed-term deposits or overnight deposits are losing their attractiveness again. However, “fleeing” into the stock markets could also be risky, as the clouded economic growth in this country and in many other industrialized countries, combined with political risks and wars, is likely to cause volatile prices.

With regard to their investment, investors therefore ask themselves which investment types and terms are recommended in the current market environment. In the case of bonds, a typical short-term investment, sentiment has recently worsened: The international interest rate turnaround is reflected in falling bond yields for the most part. While long-term bonds have remained relatively stable recently, returns on short term bonds remain under pressure. Five-year federal bonds (Bobl) currently yield less than two percent, while just a year ago they brought in around 2.7 percent.

Should investors therefore prefer long-term bonds? Not necessarily. Although the buyer of a bond is generally guaranteed to repay the purchase price, including interest, at the end of the term, long-term bonds are subject to stronger price fluctuations than short-duration bonds. They react more sensitively to changes in interest rates. For example, the start of the interest rate turnaround in the euro area two years ago put significant pressure on the prices of government bonds with a longer remaining term. The reason for this is the inverse relationship between price and return: If the yield rises as a result of a rise in interest rates, the price falls.

Advantages and disadvantages of short term investments

In summary, short-run investments based on bonds have the following advantages and disadvantages:

Benefits of short term bonds

  • Lower interest rate risk: Short-term bonds are less susceptible to interest rate changes. When interest rates rise, they lose less value than long-term bonds, as their shorter maturity reduces interest rate risk.
  • Good liquidity: Since the terms are short, the invested capital is available again relatively quickly so that investors can react flexibly to market changes.
  • Stable form of investment: Compared to long-term bonds, short term bonds are subject to less severe price fluctuations, which makes them a more stable form of investment.

Disadvantages of short term bonds

  • Lower return potential: Since the term is limited, short-term bonds often offer lower returns than long-term bonds.
  • Inflation risk: Short-term bonds may be less susceptible to interest rate changes, but their yield can be “eaten up” by inflation. If the inflation rate is higher than the interest rate, the invested capital loses purchasing power.
  • Limited run time: Although flexibility is beneficial, it also means that investors often have to decide how to reinvest the capital after the bond expires.
  • reinvestment risk: When a short term bond matures, the capital must be reinvested. If interest rates fall faster than is currently expected — in the event of a recession, for example — short-run strategies could find it difficult to reinvest the proceeds of their maturing bonds at the same high interest rates as they are currently offered.

There is no clear answer to the question of whether short or long-running strategies are the better choice for wealth creation. Instead, investors should keep an eye on the current and future financial market situation and, if necessary, adjust their portfolio to the situation. However, a good tip is always to diversify your portfolio broadly to avoid cluster risks. That generally means a reasonable mix of cash, (digitized) tangible assets, stocks, bonds, and gold.

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