There’s a lot of advice out there when it comes to investing for long-term goals like retirement. There are also a lot of tools and resources to help you find the best savings accounts for short-term goals like next year’s vacation.
But what about your goals that fall somewhere in between? What if you want to buy a house in 5 years, or your child is starting college in 8 years? How should you invest your money then?
And for that matter, what even counts as a short, medium, or long-term goal? What’s the cut-off and how do you know when to change your strategy?
This is a question I’ve been getting a lot recently, from readers, clients, and even my brother! So today I’ll lay it out for you.
Here’s what you’ll learn:
- How to decide whether something is a short, medium, or long-term goal.
- How to invest for long-term goals.
- How to save for short-term goals.
- How to decide what to do and what investments to use for all the goals that fall in between.
How to invest for long-term goals (10+ years)
Goals that are 10 or more years away give you the freedom to invest in the stock market and take on some risk in order to reach for the higher potential returns the stock market offers.
One reason is simply that with longer term goals you’ll have more time to make adjustments if things don’t go as well as planned, either by saving more or by changing your goal to make it more achievable.
The other reason is that over long time periods the stock market has always gone up.
Now, that doesn’t mean that it will automatically continue to do so, or that you are guaranteed to get the same returns we’ve seen in the past. But it does mean that you are much more likely to get at least some kind of positive return from the stock market over long time periods than you are over short ones.
So does that mean that you should put all of your long-term money into stock market? Some people do, but I generally wouldn’t recommend it.
Instead, I would encourage you to choose a mix of investments that gives you the upside of the stock market while also providing some protection during periods where the stock market falls. Here’s an article that explains how to find that balance.
For more on how to create a solid long-term investment strategy, these two articles go into a lot of depth:
How to invest for short-term goals (0-3 years)
If your goal is 3 years away or less, just put your money into a savings account.
Seriously, don’t make it any more complicated than that.
Over such a short time period the amount you save is so much more important than the interest rate you earn, that even if you DID put your money into the stock market and DID get a nice return, the difference between that and what you would get from a savings account would be small.
And the trade-off is that while a savings account guarantees that your money will be there when you need it, even conservative investments might lose you money at the wrong time.
How to invest for medium-term goals (3-10 years)
Now THIS is where it gets interesting.
When it comes to goals that are 3-10 years out, you have a number of options.
You could invest at least some of the money you’re saving for these goals, with the hope that a better return will make them easier to achieve.
Of course, the flip side is that investing the money may actually make the goal HARDER to achieve if the stock market happens to go through a rough patch. After all, with a shorter time frame you have less time to make adjustments if you don’t get the return you expected.
The truth is that there is no definitive answer when it comes to investing for medium-term goals. It really depends on the specifics of each situation, and even then your personality as an investor matters too.
So instead of telling you what to do, here are some factors you should consider as you make your decision.
How certain is your deadline?
If you have a strict deadline for when you’ll need the money, like if your child is starting college in 6 years, you should probably stick to a more conservative savings strategy. The last thing you want to deal with is a stock market drop at the wrong time, leaving you with a significant hole in your savings right when you need the money.
If your goal doesn’t have a set deadline, you’ll want to ask yourself another question…
What type of uncertainty are you dealing with?
In researching this topic I came across a great discussion in an online forum where one person talked about two different types of uncertainty you might have with these medium-term goals:
- Type 1 – You’re uncertain about the exact date on which you will NEED the money. One good example of this is an emergency fund. You don’t know exactly when that need will arise, but when it does you’ll need the money immediately.
- Type 2 – You would like to achieve the goal within some general time frame, but it could be pushed off if needed. A good example might be buying a house. Maybe it’s something you’d like to do within the next few years, but you could always continue renting if needed without any real negative impact on your life.
For Type 1 goals where you know that you will need the money at some specific point in time, even if you don’t quite know when that will be yet, it makes sense to be more conservative. Better to know your money will be there when you need it than to reach for a slightly higher return.
Type 2 goals give you more freedom to take on a little more risk. Given that you won’t NEED that money at any specific point in time, you can reach for better returns without being overly worried that it might come back to bite you.
Of course, just because you CAN take the risk doesn’t mean that you should. Which brings us to…
Do you need better returns?
Based on the amount of time between now and when you want to reach your goal, the amount of money you’ve already saved, and the amount you’re regularly adding to that savings, what kind of return do you actually need in order to reach your goal?
It may be that you don’t need anything better than what you can get from an online savings account or CD. And if that’s the case, is it worth reaching for something better at the risk of not actually hitting your savings target?
To help you figure out what return you need to shoot for, I created a simple spreadsheet that will run the numbers for you. Click here to download it.
NOTE: When using that calculator, note that small adjustments to your Monthly Savings Contribution can make a big difference in your Required Return. This is because over short time periods your savings rate is actually much more important than your rate of return, and it means that even a small increase in your monthly savings can make it MUCH easier to reach your goal. Test it out yourself by increasing your monthly savings and watching how it affects your required return.
Are you willing to watch your account value drop?
No matter how much risk you’re technically CAPABLE of taking, you may not actually be WILLING to take much at all.
Putting money into the stock market, even just a little bit of money, means subjecting yourself to the ups and downs that go with it. Everyone likes the ups, but no one likes the downs. And sometimes those downs can be pretty big.
A good rule of thumb is to expect that in any given year you could lose half of whatever money you have in the stock market. Of course you would also expect to recover that over time, but over shorter time periods that may be harder to do.
So even if you can technically afford to take on some risk, you should consider whether you want to deal with the ups and downs that come with investing and the stress that can add to your life.
What are your medium-term investment options?
Assuming you DO want to invest at least some of your money, how should you do it?
Well, first recognize that you don’t have to invest all of your money. You could very easily invest some and keep the rest in a savings account. That would give you some upside potential while also leaving you with some money fully guaranteed.
But when it comes to choosing your specific investments, here are some of the major options:
Savings accounts – Again, savings accounts AREN’T bad. You can find a good online savings account that pays around 1% in interest pretty easily, and with it you get convenience and the guarantee that your money will be there when you need it.
CDs – CDs require you to keep your money invested for a specific time period, generally anywhere from 6 months to several years. In return you can get a better interest rate than a savings account, though there are penalties if withdraw your money early. Here’s a good tool for finding the best current CD rates.
Bond index funds – Bonds are one way to dip your toes into investing without diving into the stock market. There’s still a risk of loss, but it’s not as big. And by using an index fund you can spread your money across the entire bond market, which reduces your risk a little more.
Stock index funds – The stock market offers the highest potential return of all your investment options, but also the biggest potential loss. But again, by using index funds you can at least spread your risk out over the entire market instead of pinning all your hopes on a single company.
Balanced mutual funds – Balanced mutual funds invest in a mix of stocks and bonds, which allows you to spread your money across both types of investments with just a single fund. A good example of this is Vanguard’s lineup of LifeStrategy Funds.
Remember again that it doesn’t have to be all or nothing. Finding the right mix of investments is a good way to give yourself some upside potential while limiting your downside risk.
For example, let’s say you have a goal of buying a house in 5 years. You know you’ll need about $60,000 for a down payment, but you also know that you can afford to wait longer than 5 years if necessary.
The first step is to figure out how much you should be saving. Again, this calculator will help you figure that out.
Then you can determine how you want to invest. If you’re willing to be flexible with when you buy the house, and if you’re okay with watching your account balance move up and down in the meantime, maybe you do something like the following:
- Half of your savings goes into an online savings account or CD.
- Half of your savings goes into an taxable investment account and is invested in Vanguard’s LifeStrategy Moderate Growth Fund, which is 60% stocks and 40% bonds.
That would mean that overall, 30% of your money is in the stock market, giving you some upside potential while also exposing you to some risk of losing money. But it would also mean that half of your money is protected from any kind of drop in value. So you would get some of the benefits of each approach.
Just to be clear, that isn’t meant to be a recommendation and it may not be right for your specific situation. It’s just an example of how you could strike a balance between multiple approaches.
Whatever you decide to do initially, there are two good reasons to regularly re-evaluate your savings goals with all the criteria above in mind.
First, your long-term goals will eventually become medium-term goals and your medium-term goals will eventually become short-term goals. As that happens you’ll want to adjust your strategy so that it always fits your current reality.
Second, your progress towards a goal, or lack thereof, may necessitate a change in strategy:
- A big market upswing or other big influx of cash may put you ahead of schedule. That would give you the option of taking a more conservative approach so that you could be more certain of reaching your goal on schedule.
- A big market downswing may put you behind schedule, in which case you may need to either increase your savings rate or delay your goal.
In other words, your circumstances are going to change and your investment strategy should change along with them.
Remember what really matters
Most of the time when I get the question about how to invest for short and medium-term goals, part of it is a reluctance to just put the money in a savings account.
Savings accounts feel boring. And with their relatively low interest rates it can feel like they’re not doing anything for you.
But that over shorter time periods, even periods as long as a decade, your savings rate has a MUCH bigger impact on whether you reach your goal than your return does.
Which simply means that while investing your money instead of using a savings account can help, it likely won’t be the deciding factor.
If you’re saving enough you’ll get there either way.