There are some important things to keep in mind when deciding how to invest for shorter term goals.
Understand the difference between long-term and short-term investing strategies
Whether you’re a young investor starting out, or a more seasoned investor saving for the kids’ college or your own retirement, it’s important to understand how investing for short-term goals (those within the next one to five years) is different from planning for the long term.
Although most investors share the long-term goal of retirement, shorter-term goals often vary. Near-term goals might be saving for a wedding, a big vacation, a home down payment, or a kitchen remodel. And anyone who recently welcomed a new baby to the family probably knows planning for hospital costs, infant furniture and a host of other needs is an important short term savings goal.
None of these short-term aspirations means taking an eye off of retirement. They require a different type of strategy and approach. For instance, a 401(k) may be a great option for retirement, but it’s likely not appropriate for money you’re saving for a down payment on a home.
So the question is, how to optimize investing for short-term goals without impacting long-term plans? And what are some investment choices for money that’s directed toward those big plans just over the horizon?
Establishing the timing for your short-term goals would likely be the first priority. They’ll have different time frames than long-term savings goals. Someone might plan a big vacation a year in advance or save for a down payment on a home with a three-to-five-year time frame. However, a long-term savings goal, like planning for retirement with a 401(k) or IRA, is more realistically a 30- to 40-year journey.
Next, it’s time to decide on a savings or investing vehicle for your short-term goal. It basically boils down to your choices: more aggressive investments with higher potential returns and risk, such as stocks or high-yield bonds; or more conservative choices with lower risk and returns, such as high-quality corporate bonds, money market and savings accounts, CDs, U.S. Treasury bills, or conservative ETFs.
Both high- and low-return vehicles have distinct advantages and disadvantages. At the top of the list is risk. The more aggressive a vehicle is, the more exposure it has to risk, which means it’s more likely to experience peaks and dips in value. More conservative choices can be much more likely to preserve capital, but conversely, present less opportunity for growth. It’s always important to understand the balance of return and risk when considering an investment.
You may choose to keep your short-term savings in money market accounts, CDs, and other common saving products. Or, you may choose to look at vehicles that offer a balance of risk with more growth potential. A conservative portfolio allocation with a stock component can potentially produce a greater return than a low-risk bond portfolio, although at a greater risk.
Each vehicle has its own set of advantages and disadvantages:
Although knowing where to put savings is a critical first step, you might be wondering how to allocate savings in the first place beyond what you’re already putting away for retirement. Financial experts say it’s important to take the following steps:
1. Have a plan. Whether the goal is a down payment, a wedding, or a vacation, write it down and make sure you understand all the expenses involved.
You can even adjust the details and time horizons of your plans to match your financial situation, said Dara Luber, senior manager, retirement, TD Ameritrade.
“If you’re going on vacation with $1,000 to spend, maybe it’s a car trip 200 miles away, not a Queen Elizabeth II voyage to Europe. Stay realistic,” Luber said. “And if you do want to take the QE II to Europe, you still can, but maybe it’s not in two years, it’s in five. You don’t have to give up a goal completely.”
Investors should create a plan, whether it’s an electronic spreadsheet or an old-fashioned pen on paper, said Robert Siuty, senior financial consultant, TD Ameritrade. Investors who plan their budgeting have a much better chance of sticking to it.
2. Break it down. Once you know your time horizon and understand what you’re paying for, start paying yourself. That’s right: Set up regular payments and remember to chip in a “bonus” payment when possible. For a wedding or vacation that’s a year away, perhaps it means forgoing certain expenses in the near term, such as meals out, and contributing that money instead to the event you’re planning.
“If saving for a vacation makes you happy, put it in your budget and cut down on dining out,” Luber said.
For a goal like a down payment on a home that’s three to five years away, make a point of using milestones such as pay raises to your advantage. A 3% pay raise, for instance, could all be funneled into that short-term goal without eating into retirement or college savings, and without forcing you to make lifestyle changes.
3. Set up auto deposit. The best way to save for short- and long-term goals is to set up automatic deposits from your paycheck or through your bank or brokerage. Doing so will help ensure that you stay true to your goals as well as reduce the urge to spend money on less important things.
Just about everyone needs to plan for long-term retirement savings, but short-term goals vary and deserve their own financial plans. Consider your short-term investment choices carefully as you put your plan into action. Then check the progress of your savings to stay motivated toward pursuing your goal.
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