I am a self-proclaimed member of what I like to call the “Van Clan”. No, I’m not part of the adventurous group of people that travel around the world in campervans. My wife and I just have a plain old minivan that we carry our three kids around in. Although not the coolest of vehicles, I’ll admit that it’s extremely practical, and the sliding doors are nice. However, our van keeps having issues, and we are probably going to have to replace it within the next few years.
Consequently, we have begun to set aside dollars for this future purchase, which brings up the question: “Should we invest this money?” We often get this question from clients, and our answer is usually the same; it depends.
When it comes to saving and investing, a lot depends on your time frame. A general rule of thumb is that you shouldn’t invest in stocks if you need the money in five years or less. Five years is still a relatively short time period for something as unpredictable as the stock market, so you may want to be even more conservative. The last thing you want is for there to be a market downturn without enough time for your investments to recover before you need the money.
Question: “What about investing in fixed income for shorter-term needs?”
Again, it depends. I recently wrote a blog about the two primary characteristics we focus on when choosing the bond funds in our portfolios; maturity and credit. Both are important to consider because the longer the maturity and the lower the credit quality, the more volatile the holding will be.
Here are a few thoughts on investing in fixed income for short-term cash needs:
- Overall, stick with high quality bonds. Lower quality bonds, which some advisors refer to as high yield or “junk” bonds, tend to be riskier and more correlated with equity markets, meaning they will likely go down as stocks fall.
- Short-term (1-2 years) cash needs are best met with short-term bonds, because of their lower volatility.
- Intermediate-term needs (3 years and beyond) may be better met with longer, intermediate-term bonds.
Some investors like to match their time frame with the maturity of an individual bond. For example, if you know that you have a liability coming due in three years, you could buy a bond that matures in three years to match the liability. However, there are other considerations involved in buying individual bonds, like liquidity, lack of diversification, and potentially higher transaction costs to name a few. For short-term cash needs we prefer to use either money market funds (cash) or bond funds with a duration closely matched to the investment time frame. This provides diversification and daily liquidity, often at a very low cost.
So how do you think my wife and I should invest the money we are saving for a new vehicle? Because our time frame is short (the van may stop running in three years or less!), we have opted to save this money in short-term high-quality bond funds.
Everyone’s situation is different, and there often are many things to consider before making an investment decision. It’s always a good idea to review your financial plan with your financial advisor before making an investment decision.
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