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 than planning for the long term.
While most investors share the long-term goal of retirement, shorter-term goals often vary. Depending on the investor, a big near-term goal might be:
And as anyone who recently introduced a new baby to the family probably knows, early childhood years tend to be expensive ones. Paying the hospital bill and stocking the spare bedroom with infant furniture represent important short-term savings goals for many young investors.
While none of these short-term aspirations mean taking an eye off of retirement, they require a different type of strategy and approach. For instance, a 401k may be a great option for retirement, but it’s not appropriate for money you’re saving for the down payment on a home.
So the question is, how can one 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 should be the first priority. Short-term goals have different time elements than long-term savings goals. One might plan a big vacation a year in advance or save for the 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 401k 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 whether one chooses a more aggressive choice or something that’s more conservative and lower in expected return and risk. Higher-return and higher-risk ideas might include stocks or high-yield bonds, while lower-risk and lower-return ideas may include high-quality corporate bonds, money markets and savings accounts, CDs, U.S. Treasury bills, or bonds.
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 lower 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.
While 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.
“Investors should write down 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.”
“It all comes down to having a plan and sticking to the plan and being disciplined,” Siuty said.
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,” Luber said. “Stay realistic. 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.”
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 out your daily latte,” 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 like pay raises to your advantage. A 3 percent pay raise, for instance, could all be funneled into that long-term goal without eating into retirement or college savings, and without forcing you to make lifestyle changes.
3. Set up an auto deposit. While you’ll need to settle the basic living expenses—housing, transportation, food, and such—if you’re trying to save for short-term goals, it may also be worth considering regular contributions to your savings and retirement accounts. Worried you won’t be able to regularly stick to those contributions? Most banks and brokerages will let you set up automated deposits.
Just about everyone needs long-term savings or retirement planning, but short-term goals vary and deserve their own financial plans. Considering short-term goals a little differently—and finding the right place to invest those funds—can ultimately mean more confidence in your chances of achieving both short- and long-term aspirations.
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