Because everyone knows how critical it is to save up for retirement, most investors are laser-focused on contributing to IRAs, 401(k)s and other “nest egg” investments. But what about shorter-term savings goals? Perhaps you want to create a travel fund or save up enough cash to buy a boat or vacation home within the next few years. Or maybe you are just concerned about building a liquid savings portfolio as an emergency fund.
If you have plans to make a large purchase within three to five years or you are looking to build a fund for emergency or luxury purposes, you’ll want to come up with a short-term savings strategy to meet that goal. Here are a few things to keep in mind as you devise your plan.
First, Consider Risk
Liquid savings portfolios seek to identify the lowest risk, highest return investments in the marketplace. Thus, when it comes to short-term savings, you have to approach things a little differently than you would for long-term retirement and investment goals.
For example, let’s say you plan to retire in 10 to 15 years. In this case, your financial advisor will likely recommend a diverse retirement portfolio consisting of at least 60% stocks. With such a large window of time, if the stock market takes a hit, there’s plenty of time for your portfolio to bounce back.
On the other hand, if you’re looking to save up for something in the not-so-distant future, you should steer clear of high-risk investments like stocks. Why? Because one dip in the stock market could wipe out your savings, and three to five years probably won’t be long enough for your investment to recover from the downturn. That means you’d have to kiss that trip to Europe or your beach house goodbye.
While low risk investments, generally considered safe havens, will usually have steady rates of predictable returns on a monthly basis this can fluctuate somewhat. As such, short term, liquidity seeking investors may want to overweight more heavily in risk off markets where savings rates are higher fueled by Federal Reserve interest rate policy.
Most consumers are familiar with checking and savings accounts from standard banks. However, going beyond these initial platforms can be a great first step for newly inspired short-term investors. Doing a little research to identify the best savings accounts in your area can turn up yields of 2% to 5% on standard savings account products. Many local banks offer high yield savings deals. There are also many online options. These platforms tend to offer money market accounts and high yield certificates of deposit also often associated with high yield savings as well.
The Benefits of Bonds
To achieve a short-term savings goal, you might want to take a look at bonds. Bonds generally follow high yield savings as the next step in low risk short term investing, with Treasury bonds being the safest. A bond is a debt investment in which you’re essentially loaning money to the government, a government agency or a corporate entity. Bonds are used by companies, states and cities to raise money for a variety of projects and initiatives. During a specified period of time, you’ll earn a variable or fixed interest rate on a bond. In individual bond investing you can hold your bonds to maturity or often sell them on open market exchanges.
One of the major benefits of bonds is that interest earnings are generally higher than those from a savings account. Plus, you can handpick bonds that will mature and be available by a set date in the near future. This offers a great deal of security without the risk associated with stocks. (To read more, see: The Advantages of Bonds and our tutorial, Bond Basics.) Many investors may also choose to invest in managed bond funds which can be segmented into many different risk classes and maturity segments.
Bonds, however come with their own caveats specifically in high rate or risk off markets where yields are rising. When yields on new issuances increases, prices on existing bonds fall, decreasing the secondary market trading value of bonds. In managed funds this effect can be magnified as managers hold a diversified portfolio of bonds with closely correlated volatility. Thus, bonds are especially important for the short-term investor to follow in risk off markets in order to optimize short term returns.
Across the market there are several investment products targeting short term or liquidity driven investors. Fixed income investments will generally be some of the best product options because they offer income with low risk. Investing for income in stocks may also be an option for short term investors willing to make some higher wager bets. Large cap value income investments are often the next tier of low risk options with income helping to support many investors’ short-term liquidity goals.
The Bottom Line
As you are looking to save up for short-term goals, it’s important to choose your investments wisely and stay abreast of market changes in the low risk investing segment of the market. If you want to have access to the money within three to five years, high yield, low risk investments are your best bet and most stock investments will be too risky. However, managing a short term portfolio with a select few stock investments specifically in the large cap value income category can be one way to boost some return.