How to Invest for Medium-Term Goals

There’s plenty of advice when it comes to investing for retirement. And there are plenty of resources to help you find the best savings account for your near-term needs.

But what about your medium-term goals? What if you want to buy a house in five years? Or what if your child is heading to college in eight years?

How are your supposed to invest for goals that aren’t decades away and aren’t coming up in the next couple of years?

This article will help you figure it out.

What Are Your Investment Options for Medium-Term Goals?

Before you start making any investment choices, you need to know what your options are. And while there are many, many different specific choices you could make, here are the broad categories that most of those choices fall into.

Savings accounts: Savings accounts shouldn’t be overlooked as a viable option, especially if you need a specific dollar amount by a specific date in order to achieve your goal.

CDs: CDs often provide a slightly higher interest rate than savings accounts, but there are two potential downsides to consider. The first is the fact that you might be penalized if you withdraw the money early. The second is that if interest rates continue to rise, it may not be long before you’re able to get a better interest rate with a savings account than from whichever CD you buy today.

Bond index funds: Bond index funds are one way to take on a little more risk in search for better returns. Since 1928, the average annual return of 10-year U.S. Treasury bonds was 4.88%, the highest annual return was 32.81%, and the lowest annual return was -11.12%. Other types of bonds will typically carry more risk.

Stock index funds: You likely won’t want to go all-in on stocks for medium-term goals, but they could be used in some proportion in order to provide a little more upside. The downside is the potential for a big loss, especially if it’s right before you need the money. Since 1928, the average annual return of the S&P 500 was 9.65%, the highest annual return was 52.56%, and the lowest annual return was -43.84%.

All-in-one mutual funds: There are plenty of all-in-one funds that provide a stable mix of stocks and bonds. If you’re saving for college, 529 plans in particular typically often offer age-based all-in-one funds that could be a good fit.

How to Find the Right Balance

With those as your main options, how do you mix and match to find the right investment balance for your specific goals?

Here are a few questions to ask that will help you narrow it down.

1. How soon is your deadline?

The sooner you’ll need the money, the more conservative your investments should be.

A reasonable rule of thumb is to expect that in a market crash, you could lose half of whatever money you have invested in the stock market in any given year. You would also expect to recover that money over time, but doing so may take several years.

Of course, recovering that loss over several years requires that you have several years to wait for the recovery. If you don’t, you should probably avoid putting too much money into stocks.

2. How certain is your deadline?

If you need a specific amount of money by a specific date, the margin for error is smaller and you may therefore want to choose a more conservative mix of investments.

But what if you have some flexibility with either the timeline or the amount of money you need?

For example, maybe you’d like to pay for your daughter’s entire college education, but you’re okay with the possibility of her taking out some loans if you can’t. Or maybe you’d like to buy a house in four years, but you’d be okay waiting six or seven years if you had to.

In cases like that, you may be able to take on a little more risk since the downside isn’t actually that bad.

3. What rate of return do you need?

If you’re able to save a lot of money for your given goal, you may not actually need much of a return in order to reach it.

As an extreme example, let’s say that in five years you want to have $50,000 available for a down payment on a home. If you’re able to save $833.33 per month, you’ll have exactly $50,000 in five years, even with a 0% return.

If you’re saving enough money to reach your goal with only a modest return, it’s probably not worth the risk of reaching for a better return. The downside will almost always be more significant than the upside.

4. Are you comfortable with the ups and downs of the market (especially the downs)?

Even if your goal is flexible and you can technically afford to take on some risk, it’s worth asking whether you’re emotionally prepared to deal with the ups and downs (and especially the downs) of the stock market.

Would you be comfortable seeing 30% of the money you’re saving up for a house disappear during a market crash? If not, then putting 60% of your savings into the stock market isn’t a good idea, even if the other factors might argue for that type of aggressiveness.

How to Find Your Personal Balance

The tough part about a question like this is that there is no definitive answer. Even with accurate answers to all of the questions above, there is no way to say exactly how much of your savings you should put into a savings account, or bonds, or stocks, or anything else.

But you can certainly get in the ballpark and find a balance that feels right to you. Here’s one way to approach it:

  1. Use an asset allocation questionnaire, like this one provided by Vanguard, to get a starting point for your target asset allocation.
  2. If, after answering the four questions above, you feel like you need a more conservative approach, shift some or all of the suggested stock allocation to bonds and some or all of the suggested bond allocation to savings accounts or CDs.
  3. If, after answering the four questions above, you feel comfortable with a more aggressive approach, shift some of the suggested bond allocation to stocks.

Above all, remember that what’s really important here is simply meeting your goal. Nothing else matters, including the potential of missing out on better returns from other investments.

Matt Becker, CFP® is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families.

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Matt Becker

Contributor for The Simple Dollar

Matt Becker, CFP® is a fee-only financial planner and the founder of Mom and Dad Money where he helps new parents take control of their money so they can take care of their families. His free time is spent jumping on couches, building LEGOs, and goofing around with his wife and their two young boys.