If a big expense is staring you down, here are some important things to keep in mind when deciding how to invest for that shorter-term goal.
Understand the difference between long-term and short-term investment strategies
While wrestling with pandemic-related shutdowns and a rough economy in 2020, many investors likely found it difficult to focus on their financial goals.
Shorter-term priorities—such as finding new employment after a layoff, making sure the kids don’t play video games all day, or helping elderly parents who suddenly couldn’t be visited—might have taken precedent.
That’s all completely understandable, considering the unprecedented circumstances. By this point, hopefully things are smoother. If that’s the case, it’s important to return to your financial goals and how long-term and short-term investing goals can vary. Investing for short-term goals (within the next one to five years) is very different from planning for the long term.
Although most investors share the long-term goal of retirement, shorter-term goals often vary, at least once normal times return and COVID-19 is in the rearview mirror. Near-term goals might involve saving for a big purchase such as a wedding, a vacation, a home down payment, or a kitchen remodel. And anyone who recently welcomed a new baby to the family probably knows that 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 mean taking an eye off 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 a down payment on a home.
So, how do you 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 expenses just over the horizon?
Establishing the timing for your short-term goals would likely be the first priority if you’re ready to get back to normal following the pandemic. Different investors likely have different time frames for their 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 exchange-traded funds.
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 may be more likely to preserve capital but conversely offer 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 savings products. One risk with these is that nearly all of them now pay virtually zero interest, thanks in part to the Federal Reserve’s pandemic-related monetary stimulus, which includes keeping interest rates rock bottom. 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, according to 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 two-week Alaska vacation. Stay realistic,” Luber noted. “And if you do want to hike in Denali, 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, explained 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 instead contributing that money 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. This might be easier now, considering the opportunities to dine out kind of shriveled up in 2020 and early 2021. With restaurants reopening, the temptation might be to go back, and there’s nothing wrong with a treat now and then. Still, consider making these treats more special by not returning to your pre-pandemic dining out habits if you have a short-term savings goal in mind.
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.
Another thought: Are you one of the millions of Americans who received stimulus checks? If you haven’t already thought of what to do with the money and still have some around after dealing with your bills, maybe some of that can go into your “milestone” savings bucket.
3. Set up automatic deposits. 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.
Carefully consider the investment objectives, risks, charges and expenses before investing. A prospectus, obtained by calling 800-669-3900, contains this and other important information about an investment company. Read carefully before investing.
Do Not Sell or Share My Personal Information
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Money market funds, like mutual funds, are neither FDIC-insured nor guaranteed by the U.S. government or government agency and are not deposits or obligations of, or guaranteed by, any bank. There can be no assurance that these funds will be able to maintain a stable net asset value of $1 per share. It is possible to lose money by investing in money market funds. Tax exempt funds may pay dividends that are subject to the alternative minimum tax and also may pay taxable dividends due to investments in taxable obligations.
All investments involve risk, including loss of principal.
Investments in fixed-income products are subject to liquidity (or market) risk, interest rate risk (bonds ordinarily decline in price when interest rates rise and rise in price when interest rates fall), financial (or credit) risk, inflation (or purchasing power) risk, and special tax liabilities. May be worth less than the original cost upon redemption.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2023 Charles Schwab & Co. Inc. All rights reserved.