Whether the market is up or down, younger investors get the same advice over and over: Invest consistently in a broadly diversified stock portfolio, and don’t look back.
If you’re investing for a long-term goal, such as retirement, this thinking is sound. Compared with other types of investments, stocks offer a high potential return on your money. They come with a higher likelihood of short-term losses, but if you’re investing over the course of decades, those aren’t likely to do much damage to your portfolio in the long run.
But retirement isn’t the only thing young people are saving for. Between now and whenever you stop working, you likely have a lot of milestones you’re hoping to hit, such as buying a home or planning a wedding, and you’ll need money to pay for them.
If your goal is just a few years away, you’d be wise to focus less on growing your money and more on preventing a market drawdown from taking a big bite out of your savings, experts say.
“I’d view those investments in a highly defensive posture,” says Naveen Neerukonda, a certified financial planner with PVA Financial in Chicago, Illinois.
How to invest for short-term goals
Say you want to put a down payment on a house sometime over the next three years. Theoretically, you could boost the amount you’re stashing away if you put the money in a stock market that shoots up.
“The danger is, you put it in stocks, you find a house you like, the market takes a crash, and now you’re not able to buy that house,” says Charles Rotblut, vice president of the American Association of Individual Investors.
The sooner you’ll need the money, the more you should defend against sharp drawdowns that can derail your plans, financial advisors typically recommend. That means that your shortest-term money likely belongs in cash — not even in a relatively conservative asset, such as bonds, which can still lose money.
“2022 is a sober reminder that, while bonds are safer investments than stocks, they can decline and are decidedly tied to underlying interest rate changes,” says Kevin Brady, a certified financial planner and vice president at Wealthspire Advisors in New York City.
Even though money you hold in a cash account is unlikely to keep up with inflation, it still beats the possibility of a decline in value forcing you to change your plans. “If the value of the principal is important, holding most of the amount in cash in a high-interest savings account is the right decision,” Brady says.
How to invest for more intermediate-term goals
Let’s say your goals are a little more flexible, and you’re looking to make a major purchase in three to five years. Building a portfolio for those kinds of goals “becomes a tough call,” says Brady, but generally involves a mix of cash, bonds and, for some investors, stocks.
How much you allocate to those assets will depend on your personal tolerance for risk. But remember that your primary goal is to protect, rather than grow, your savings.
“In that three- to five-year environment, you still want to think about preserving your cash,” says Rotblut. To maximize the interest you earn on cash, “think about exploring high-interest savings accounts or [certificates of deposit].”
Stick with bonds that are unlikely to default or lose value if central banks continue to raise interest rates. Your best bet against defaulting: bonds backed by the U.S. government, such as Treasurys or Series I savings bonds, which pay an interest rate tied to movements in inflation.
Because interest rates and bond prices move in opposite directions, look for bonds with a low duration — a measure of a bond’s interest rate sensitivity. Shorter-term bonds, which mature sooner, tend to come with shorter durations.
“I wouldn’t extend the duration past the point where you want the money back,” says Neerukonda. That means a bond mutual fund or ETF with an average duration of three years could be appropriate for an investor who plans to use the money for a goal three years away.
Some advisors recommend adding stocks to an intermediate-term portfolio, but only for investors comfortable with taking on a certain level of risk. “If you’re not willing to tolerate a 30% decline in that part of your portfolio, you shouldn’t be in equities,” says Neerukonda.
If you’re comfortable with that risk level, Neerukonda recommends sticking to high-quality, dividend paying stocks. These stocks, which tend to be issued by companies with strong cash flows and little debt, are still likely to go down in value when the broad market slides.
But in tough economies, he says, “these are the companies that tend to survive.”
