How should you invest your money if you’re saving for a short-term goal? If your investment time horizon is less than five years you should not invest in the stock market because the market is meant for investors with a 20-year time horizon or longer. So where should you put your money if you want to keep it safe but still earn a positive return? Some possible investments include money market funds, bonds and CDs.
To decide which investment is right for you, consider how many years it will be until you need the money. Then match the investment time horizon to your goal. For example, if you need money for a new car down payment in two years, buy a fixed two-year investment like a bond or CD that will mature when you need money.
But what if you require a higher return that only the stock market can provide? What if a bond or CD won’t produce enough investment return to fund your goal? The answer is simple: You can’t afford it! You don’t want to find yourself in a position where you’re living beyond your means and relying on the stock market to bail you out; that’s gambling not investing. If the market underperforms like it has the past two years you’ll find yourself in serious financial trouble.
Always match the investment time horizon to your goal. Here’s how it works:
1-Year Investment Time Horizon
If you need your money in less than one year you should keep it in a liquid savings account or money market account where it will earn interest but still be safe and easily accessible.
2 to 5-Year Investment Time Horizon
If you need your money in a specific number of years then invest in a CD or bond with a fixed maturity date that matches your time horizon. CDs and bonds can be purchased at most banks or credit unions and offer fixed maturity dates. If you’re in a high tax bracket consider purchasing a municipal bond, otherwise buy a CD or a highly rated corporate or government bond.
Laddering Cash Flows
If you need money each year, for a set number of years, then ladder your cash flows. An example might be paying college tuition each year, for four years. Here’s how you could ladder cash flows to pay for college:
Year 1: Take the money you’ll need to pay for the first year and keep it in a money market account.
Year 2: Buy a 1-year CD that will mature to fund year two’s financial obligation.
Year 3: Buy a 2-year municipal bond that will mature to fund year three’s financial obligation.
Year 4: Buy a 3-year government bond that will mature to fund year four’s financial obligation.
Remember: Keep your money out of the stock market if you’re saving for a short term goal!
If you plan to ladder cash flows there are a number of suitable investments with fixed maturity dates to consider. Some of them include treasury bills, corporate bonds, commercial paper, and bond funds, just to name a few. Check with your local bank or credit union for a complete list of the investment alternatives available to you, and make sure your selection keeps your money safe and out of the stock market.
Matthew Brandeburg, CFP® has five years of fee-only financial planning experience and runs his own financial advisory practice. He can be reached for comment at 614.477.7350.