You’ll find plenty of advice on which stocks are hot and how to invest in the stock market. However, many of these conversations leave out an important consideration: Why are you investing?
Investment market manager at financial firm PNC Wealth Management D. “We really think it’s best if you take a goal-based investing approach,” says Keith Lockyer. Next year’s vacation cash must be treated differently than 20 years’ worth of retirement cash.
The concept of risk versus reward is central to smart investing. You don’t want to risk and lose your money before you need it. However, keeping money in safe investments such as bonds may yield few returns and mean you may not have enough for your long-term goals.
Here’s a look at savvy short- and long-term investment strategies that will help you balance risk and reward depending on when you need your cash.
Short term savings
When it comes to money for short-term goals, finance experts say people should focus on saving rather than investing. Money due in less than three years needs to be protected against market volatility.
“Short-term [investing] is where people make mistakes,” says Oliver Lee, owner of Strategic Planning Group in Lake Orion, Michigan. “They see the bright light that says 6 percent and jump in.” However, those kinds of returns usually require people to take risks that they will need sooner rather than later.
For short-term goals, try one of the following short-term investments:
- High generated savings eats.
- CD ladder and money market accounts.
- Short Term Bond Fund.
- Fixed Income Fund.
- Structured notes.
high generated savings account
People should forget about investing money required in less than a year. Instead, look for a high yield savings account to keep the money safe and available immediately. Online banks like Goldman Sachs and Barclays’ Marcus are offering up to 2% APY on their high yield savings accounts. Although not as much as can be earned in investments, the money in the savings account is insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC) and is therefore protected against any loss.
CD ladder and money market accounts
You can earn a little more by putting money in a certificate of deposit (CD) instead of a savings account. However, the best rates are only available if you agree to tie up your money for at least a year or more. To hold cash, some people ladder CDs with different maturity dates. This approach ensures that a minimum portion of the savings is available at any given time.
Money market accounts are another short-term investment option. “While the Fed is currently cutting rates there are a number of money market funds that offer reasonable yields for short-term cash,” says Lockyer. They can offer comparable interest to some CDs and come with fewer restrictions. However, you may only be allowed to withdraw a limited amount from the account each month.
Short-term bond funds
Once one’s time horizon goes beyond 18 months, it makes sense to keep money in relatively stable short-term investments. Short-term bond funds are a way to maximize returns with relatively low risk.
However, the returns on these funds are minimal compared to other investments. Ten-year annualized returns for most bond funds are around 2% to 4%.
Fixed Income Fund
Similarly, fixed income funds offer a relatively stable way to earn higher returns than those offered by savings or money market accounts. Most of these funds include bonds, but they may also include other securities. Fixed income funds don’t offer much in the way of returns, but they are at least designed to minimize market risk and limit losses so they can be good short-term investments.
Michael Windle, a certified retirement income professional and owner of C. Curtis Financial in Plymouth, Michigan, says people sometimes make the mistake of thinking they need to save thousands of dollars before investing in fixed income or other market funds. “Instead of putting money in a savings account, just put it [in investments],” he says. Doing so can help improve overall returns.
Windle likes this short-term investment option for those who may have years before they need the money. “They follow a bucket of stocks and indices,” he says.
Structured notes offer a diversified investment that minimizes the risk of losses while offering customized returns. “They pay higher interest and take some downside risk,” says Windle. They can pay as much as 6 percent interest, but be prepared to hold the note until maturity as it may be difficult to sell them after issuance. As their terms can be complex, structured notes are best purchased under the guidance of a financial advisor.
Long term investment
For money that won’t be needed for at least three years, consider putting at least a portion in stock market equity. Since most bear markets last for nine to 16 months, an investor with a five-year time horizon is exposed to the risk of a market downturn. Their investment will grow again before they need the cash. However, to be safe, people should start moving money into bonds and fixed income funds because when will it be used for its intended purpose.
Mark Charnette, founder and CEO of American Prosperity Group, a financial company in Pompton Plains, New Jersey, says workers need to be aware of how long they have to recover from losses. As retirement approaches, they need to shift their money toward more conservative, lower-risk investments.
As for where to park money for long-term needs, financial professionals recommend the following long-term investments:
- 401(k)s and IRAs.
- 529 plan.
- Index funds and ETFs.
401(k)s and IRAs
Whenever possible, money for retirement should go into one of these tax-advantaged accounts. Employer-sponsored 401(k) plans may come with a company match for employee contributions. Also, retirement accounts, including IRAs, offer either an immediate tax reduction or future tax-free withdrawals, depending on whether a traditional or Roth account is used.
“To determine which type of retirement plan would be the best choice, you need to analyze your current tax situation, level of retirement contributions, and your projected retirement income from all sources,” says Charnette. “That will help you decide whether the current tax deduction is worth paying taxes on future income over your lifetime.”
Many schemes offer multiple fund options and for those who don’t want to bother monitoring and revising investments as they age, target date funds can be the best option. A target date fund is set based on when a person expects to retire. As that year approaches, the fund automatically shifts money into bonds and other less volatile investment options.
For college savings, a 529 plan is a long-term investment option. These schemes offer tax-free withdrawals for eligible educational expenses. Some states allow residents to deduct contributions from their state income tax. Like the retirement plans above, 529 plans often include target-date funds that can be chosen based on when the child reaches college age.
“You can be more aggressive to start with and then be more conservative when you’re closer to your goal,” says Windle. Like other equity investments, 529 plans can lose money in down markets, and transitioning to bonds or fixed-income funds can reduce the chance of losses for the older child.
Index funds and ETFs
When it comes to money for long-term goals like buying a home or starting a business, opening an investment account through a brokerage is the best way to put money aside. Among these accounts, index funds and exchange traded funds (ETFs) offer the lowest fees and best value.
While index funds aim to track the overall market, ETFs can be more volatile. Both have a portfolio of securities that helps spread risk, but investors should do plenty of research before sinking money into a particular fund.
Actively managed funds are another option for long-term investing. While they may come with higher fees, they may outperform index funds and some ETFs. However, increased profitability means that they are more sensitive to market volatility.
One of the mistakes people make with these funds is losing sight of why they’re investing the money, Lockyer says. “They focus on beating benchmarks rather than goals,” he explains. As with every other long-term investment, the promise of financial reward must be balanced against the risk of losing money before it is necessary. Check with a financial planner to learn more about which funds are right for your goals and risk tolerance.