This article is a part of a month-long Morningstar Money Challenge. You can find the details here.
We’re halfway into our Month-long Money Challenge, and I’m feeling pretty good! On Day 9 we discussed setting overall financial goals. Today, we’ll dig deeper into intermediate-term, or mid-term goals.
For goals that are immediate – say you’ve been saving to buy a car in the next few months, or you’re building up your emergency fund – you need to have your funds stored in a very liquid, ultra-safe way. You’ll need quick and easy access to these funds, so it might not be worth the risk to venture into assets that could give you more yield.
As Morningstar’s director of personal finance Christine Benz says, “It's boring, but you'll need to rely on your own savings, rather than investment returns, to do the heavy lifting in these instances.”
Also, remember that your own savings rate matters. “If returns from reasonably safe asset classes are apt to be muted during your holding period, you may need to step up your savings rate to achieve your goal rather than relying on portfolio returns to do the heavy lifting,” she says.
Additional Reading
- Investing for Short and Intermediate Goals
- Quantify and Set Goals
With intermediate-term goals, you have a little more wiggle room. Say if you’re unlikely to need access to your funds for two years or more, you might be able to handle a little bit of volatility in the value of your nest egg. Always remember, this depends entirely on your risk capacity and risk tolerance.
“Investors may confuse their risk capacity with risk tolerance, for example, venturing out on the risk spectrum and incurring losses just before they need to tap their portfolios. Or they might assume that just because stocks have delivered returns that have bested other asset classes' in the past five years, they'll do it again during the next five. At the opposite, conservative extreme, investors might assume that the best way to meet short- and intermediate-term goals is to stick exclusively with guaranteed products. But if the investor's time horizon is longer than a couple of years, the bite of even modest inflation means that guaranteed products will be a losing proposition,” Benz noted.
So what should you do?
If you're investing for short- or intermediate-term goals, here are the key steps Benz recommends you take.
Step 1: Quantify goals and set a time horizon.
Step 2: Consider where you'll be saving and investing.
Step 3: Identify appropriate investments for short-term goals (less than two years away).
Step 4: Identify appropriate investments for intermediate-term goals (between three and 10 years away).
Where to Invest?
If your time horizon is between five and 10 years, which is where most people would place their intermediate-term goals, Benz notes that you can afford to take a bit more risk and you might even consider a dash of equity exposure, especially if you have a time horizon of close to 10 years.
She warns that you'll also want to include ample cash and short-term bond funds.
These are the investment types that can make sense for time horizons of between five and 10 years:
- Cash investments
- Short-term bond funds
- Intermediate-term bond funds
- Conservative-allocation funds
- Moderate-allocation funds
- Large-company equity funds (in small doses)
Additional Reading
- A Basic Look at Asset Allocation
- On Cash Flows and Budgets
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