Most investors are laser-focused on contributing to IRAs, 401(k)s, and other “nest egg” investments because everyone is aware of the importance of saving for retirement. However, what about shorter-term savings objectives? You may wish to create a travel fund or save enough money to purchase a boat or vacation home in the coming years. Alternatively, you may be concerned with building an emergency savings portfolio.
If you intend to make a large purchase within the next three to five years, or if you wish to build a fund for emergencies or luxuries, you will need to devise a short-term savings plan. Here are some considerations to keep in mind as you formulate your plan.
Consider the risk first.
The objective of liquid savings portfolios is to identify the market’s lowest-risk, highest-return investments. So, you need to save for the short term in a different way than you would save for retirement or invest for the long term.
For instance, suppose you intend to retire in 10 to 15 years. In this case, your financial advisor will most likely recommend a diversified retirement portfolio with at least 60% stocks. With such a large window of time, if the stock market takes a hit, your portfolio has ample time to recover.
If, on the other hand, you intend to save for something in the near future, you should avoid high-risk investments such as stocks. Why? Because a single stock market decline could wipe out your savings, and three to five years is probably not enough time for your investment to recover. That means you would have to cancel your trip to Europe or the beach house.
Despite the fact that low-risk investments, which are generally regarded as safe havens, typically offer steady, predictable monthly returns, this can fluctuate somewhat. As a result, investors who are looking for liquidity in the short term may want to put more money into risk-averse markets with higher savings rates because of how the Federal Reserve sets interest rates.
Money Market Accounts
The majority of consumers are acquainted with checking and savings accounts from conventional banks. For newly inspired short-term investors, however, expanding beyond these initial platforms can be an excellent first step. Researching the best savings accounts in your area can result in yields ranging from 2% to 5% on standard savings account products. Numerous local banks offer lucrative savings accounts. There are also numerous options online. Typically, these platforms offer money market accounts and high-yield certificates of deposit, as well as high-yield savings accounts.
The Advantages of Bonds
To achieve a short-term savings objective, you may want to consider bonds. As the next step in low-risk short-term investments, bonds typically follow high-yield savings, with Treasury bonds being the safest. When you purchase a bond, you are essentially lending money to the government, a government agency, or a corporation. Companies, states, and municipalities use bonds to raise funds for a variety of projects and initiatives. On a bond, you will earn variable or fixed interest over a specified time period. Individual bond investors have the option of holding their bonds until maturity or selling them on open market exchanges.
One of the primary advantages of bonds is that their interest earnings are typically greater than those of savings accounts. Additionally, you can select bonds that will mature and become available at a specified date in the near future. This provides substantial security without the inherent risk of stocks. A lot of investors may also choose to put their money into managed bond funds, which can be broken up into many different risk classes and time frames.
However, bonds come with their own caveats, particularly in high-rate or risk-averse markets with rising yields. When yields on new issuances rise, prices on existing bonds fall, reducing the value of bonds on the secondary market. This effect can be amplified in managed funds where managers hold a diversified portfolio of bonds with closely correlated volatility. Short-term investors must follow bonds in risk-free markets if they want to make the most money in the short term.
There are numerous investment products on the market that target short-term or liquidity-driven investors. Generally speaking, fixed-income investments will be among the best product options because they offer a low-risk income. Short-term investors who are willing to place larger wagers may also be able to invest in stocks for income purposes. Large-cap value income investments are often the next-best low-risk income options, which helps many investors reach their liquidity goals.
As you look to save for short-term goals, it is important to choose your investments carefully and monitor market changes in the low-risk investing segment. If you need access to the funds within three to five years, low-risk, high-yield investments are your best bet, as the majority of stock investments are too risky. But one way to increase return is to manage a short-term portfolio with only a few stock investments, especially in the category of large-cap value income.