We know we should be saving for short-term goals like that beach vacation and for emergencies and investing for that ultimate long-term goal of retirement. But it’s a little less clear what we should be doing with cash we need for all that time in between. (You know, life.)
Turns out, we should still be investing—even if our financial goals aren’t so far off.
It’s true that investing comes with risks—but so does not investing.
The biggest threat is inflation, or the overall increase in the price of popular goods and services. “Inflation is going to eat away at your money like termites would eat a house. It’s slow, and you don’t notice it all at once, but suddenly your house is about to crumble,” says Stacy Francis, Certified Financial Planner and CEO of Francis Financial in N.Y. “If you leave [your savings] in cash, it doesn’t become a problem until five or 10 years down the line when you need it and realize it’s worth [less] of what it used to be.”
That’d be less of an issue if you could earn a good return on your cash by leaving it in the bank. But savings accounts currently have an average yield of just 0.06 percent, according to the latest FDIC survey. While the consumer price index (which measures price changes in consumer goods and services like gas, food, clothes and cars) was up 2.7 percent in February, compared to last year.
By not investing, you could also miss out on compounding (essentially, when the money you earn starts earning money, too). Investing early gives your money time to grow—then gives that new money time to grow, too.
After you’ve squared away a few other priorities, like setting a budget that helps you spend less than you earn, pay down any debt quickly and squirrel away money for emergencies. That ultimately gives you the flexibility to earmark some money for investing—allowing you to have more confidence and handle greater risks. Keep in mind that it doesn’t take a lot of money to start investing. (Micro investing apps like Acorns let you invest as little as $5.)
Set goals for your investments and determine what type of account is best. For most, you can just stick with a regular brokerage account. But if you’re saving now for your kid’s future college expenses, you might also open a 529 plan.
Next, plot out your timeline. College for a newborn might be 17 years away—then you’ll have a few years to draw down the balance. On the other hand, if you’re saving for a home, you’ll probably need to withdraw the money at once when you’re ready, though you may have some flexibility around when you make the purchase. Other goals could range from saving for a new car or a wedding that’s a few years away to putting away enough money now to start your own business later.
Knowing your target date helps inform your asset allocation. Francis recommends a portfolio consisting of 70 to 80 percent stocks for goals more than five years away. As you get closer to your deadline, you can switch to a more conservative portfolio, so that you’re more heavily invested in bonds than stocks.
At around the five-year mark, you can start adjusting down your risk. Typically this means switching from stocks to bonds, though Francis suggests dialing it back in more subtle ways, too.
Within your stock holdings, you can lighten up on higher-risk foreign stocks, such as those in emerging markets. Then do the same for small-company stocks, opting instead for higher quality, large-company stocks. You may also consider moving into more dividend-producing stocks, which provide additional income.
As for bonds, Francis recommends moving from long-term to shorter-term bonds, and making sure you’re well-diversified. (Investing in bond funds or ETFs rather than individual bonds is a good way to do that.) “Everybody talks about being diversified with their stocks, making sure they don’t have all their eggs in one basket,” says Francis. “That advice is also important for your bonds.”
By the time you near your goal, a more conservative portfolio would be about 70 percent bonds, 30 percent stocks, says Francis—meaning you’re still holding some stocks till the end. After all, stocks generally provide the greatest returns, which is what investing is all about (although they also carry the most risk).
“You worked hard to put this money away; your money should also work for you,” says Francis. “Your money is an engine to help propel you forward to your goals. Do you want an engine that’s in a Lamborghini, or do you want an engine that’s in one of those Barbie Corvette cars for 2 year olds? I know which I would prefer.”