Higher-risk options for short-term goals

If there's a major purchase in your near future, you can accumulate the money without playing it too safe.

Jess Morgan 26 October, 2015 | 5:00PM

If you're not willing to take on too much risk to achieve your short-term goals, you might invest in money market funds, Treasury bills, guaranteed investment certificates (GICs), Canadian short-term bond and mortgage funds or high-interest savings accounts. You're sure to not lose money -- but you won't make much.

What if your aim is to make a little extra on top of the amount needed for that big purchase? Chances are you want bigger returns than what these slow-and-steady products can offer. That means moving out of your comfort zone and diversifying your short-term portfolio with higher-risk securities.

"If they're saving for the short term, traditionally most people's course of action is a savings account," says Alex Sloat, an Ontario-based financial consultant with Investors Group. However, he says, investment vehicles with bigger risks offer plenty of opportunities for the short-term investor.

Sloat often recommends a portfolio of 80% bonds and 20% stocks for investors with a two- to three-year time horizon.

"I've had several clients invest that way," he says. "It's an investment mix that doesn't tend to lose a lot of money, even if another 2008 crash happens. But it has a lot better long-term growth than a savings account."

According to Sloat, the fixed-income market provides stable holdings for short-term investors hoping to "get a little bit more aggressive" with their approach.

"Bonds are a good place to start for someone who's willing to take a little bit of risk," he says. "They are fairly secure, but they do have more general long-term growth and a bit more upside potential."

The fixed-income market is not uniform, of course; investors will need to consider their risk tolerance when choosing between government and corporate bonds. In the case of the latter, Sloat advises investing in a fund of bonds, "because that way you've got the ability to survive if one company goes bankrupt."

Michael Keaveney, director of the Morningstar Investment Management division of Morningstar Canada, agrees that this is a prudent approach. That said, the value of even a fund of bonds will be affected by the credit ratings of the underlying issuers, as well as economic factors. "Most bonds have fixed coupon payments. Over time, inflation is the enemy of fixed payments, as the same dollar amount paid out buys fewer goods and services," he says.

Bonds also carry the risk of losing their value when interest rates increase. Sloat says short-term investors should keep their interest rate risks fairly low. The one exception is for those saving for a down payment on a house, since house prices also tend to fall when interest rates rise, thereby compensating for losses in bond values.

On the other hand, Sloat warns, if you're saving to buy a car, or take a trip to Europe for a month, "that doesn't really hedge you in the same way."

The 80/20 split between bonds and stocks isn't a hard rule, Sloat says: "If you want to get more aggressive, you can always jack up the stock percentage further."

However, cautions Keaveney, "Adding stocks to an investment portfolio with a short-term time horizon requires accepting the chance of a disappointing outcome. Instead of the optimistic view of being able to make your planned purchase, or perhaps even a better version, you would be wise to think about whether your major purchase is achievable at all if you suffer a shortfall, and whether you'd still be in a position to make your purchase, albeit in a toned-down flavour."

To avoid gambling on equities, a short-term investor might be better off investing in stocks via ETFs or mutual funds that are well-diversified across sectors and geographies. It may also be a good idea to stay away from small-cap stocks, which are riskier than their large-cap counterparts.

"Having some money in small caps can make sense, but, as with everything, the goal is to put it in the context of a broader financial plan," Keaveney says. "They do tend to be very volatile, and the goal is to make your major purchase, not to just gamble on the market."

An investor on a deadline may find target-date mutual funds appealing. These are portfolio funds that start out emphasizing growth-oriented investments, and become more conservative as their maturity date nears. Although these funds are typically marketed to investors approaching retirement, some fund providers, including RBC and BMO, offer suites of "Target Education" funds, including RBC Target 2020 Education and BMO Target Education 2020. While primarily designed to fund post-secondary education, these are available to anyone whose deadline for their investment goals matches the target year, with asset mixes that shift from a balance of equities and fixed-income securities to all cash by that year.

About Author

Jess Morgan

Jess Morgan  Jess Morgan is the associate editor of Morningstar Canada’s website. She began her career as a television producer and freelance writer, often making appearances on TV and radio as a commentator on politics and culture. She holds a BA in communications from the University of Winnipeg and a diploma in Creative Communications from Red River College.