I often see questions about how to invest money in the short term, like 1-5 years. Sometimes it is phrased as “I need a safe investment for money I need in a year or two,” but doesn't give a definition of “safe” nor the reason the money is needed.
A similar question was asked recently in the WCI Facebook Group:
Q. One of our kids has $40,000 she wants to invest. She wants a decent gain and for it to be liquid in one year. Therefore, she’s not going to put it in her stock or retirement accounts. Any wise advice would be appreciated!
Answers given were mostly excellent as usual such as this one:
although there were several that were not (admittedly some may have been said in jest):
Obviously I'm not a big fan of buying individual stocks, Bitcoin, or narrow sector ETFs at all. Acorns, (one of my worst-paying affiliate partners), for those who are unaware, is an interesting company that is really aimed at those with low incomes/balances but allows you to automatically invest very small amounts at a time into one of various solid diversified portfolios ranges from 20% stocks to 100% stocks for $12-36/year plus the fund expense ratios.
Investing For the Short Term
Let's talk for a few minutes about investing in the short run. There are really three considerations about short term investments we need to discuss here.
# 1 Liquidity
The first is actually the easiest — liquidity. Some investments are liquid and some are not. For example, for money you need in one year, it would be foolish to invest in something like an individual rental property. Direct real estate is terribly illiquid. At best, you can sell it in a few months, but you could potentially be forced to hold it for years longer than planned. In addition, there are transaction costs that would likely eat up most or all of the gain you would expect in a year. Even if you had a really great year, you could still lose all the gains just to the transaction costs. If you think a house is a one-year investment, you had better be a professional house flipper with a keen eye for opportunities.
However, many investments are plenty LIQUID to use for a one-year investment. Obviously a savings account, one year CD, or money market fund are liquid. But so also are publicly traded stocks, treasuries, ETFs, and most mutual funds. You can easily sell them any day the market is open. They do meet the liquidity criteria.
Although there are ways to get money out of retirement accounts penalty-free prior to age 59 1/2, retirement accounts generally aren't a good place for the young to invest short term money.
# 2 Risk of Loss
The second issue with short term investing is a lot more nuanced-risk. The traditional thinking has been not to invest money in stocks that you need at any point in the next five years. The reason for this is that stocks are quite volatile. According to Vanguard, an investment in US stocks lost money in 25 out of 92 years between 1926 and 2017. Although the annualized return over that time period was 10.1%, that ranged from +54% to -43%. That obviously introduces a lot of risk that you might not have the money you need in a year.
In those time frames, the return OF your principal often matters a whole lot more than the return ON your principal. By holding an investment at least five years, you reduce your risk of losing money, on a nominal basis, from 25/92 (27%) to about 10%. (In case you're wondering, there are no historical 15 year periods where stocks have lost money.)
The amount of money potentially lost also goes down extending out your investment period. The Balance has done a nice job of showing these in graphs.
That red line second from the right represents the S&P 500, a reasonable market for the overall US stock market. Instead of the worst loss being 43%, now it's only about 16%. At 5 years, that number drops to
about 6%. So if you invest money in the overall stock market, you have about an 11% chance of losing up to about 6% of your money. That seems like a much more reasonable risk to take than a 27% chance of losing up to 43% of your money, thus the 5-year rule of thumb.
# 3 Consequences of Loss
However, your personal risk is more complicated than just the risk of losing money. As I've explained before when I have advocated for investing your 529 more aggressively than your retirement account despite the shorter time frame, the consequences of loss matter too. You have to ask yourself, “How big of a deal is it if 5%-40% of this money is not there in a year?” If it is a really big deal, such as a wedding bill payment that must be made on that date and there are no other resources to pay it, then you had better not risk any loss at all. If it is a 20% house down payment you're investing for and you'll just use a 0% down doctor mortgage and leave this money invested for years if the market drops over the next year, then you can obviously weather the consequences of loss a lot better.
Raising kids feels short term. They grow up way too fast. These two did great on their first ascent of Lone Peak, but the summit ridge was a little scary in the snow.
So, like all investing, it should come as no surprise that you cannot invest effectively until you know what you are investing for. You MUST start with your goals. You MUST consider all of your other resources. The more other sources of funds (including investments, earned income, passive income, and credit) you have, the more risk you can afford to take, even in the short run.
Once you add both risk and the consequences of risk into the equation, different people can come up with all kinds of different ways to invest money for 1-5 year time periods, all of which meet the liquidity criteria. But the same principles apply to short time periods as long time periods:
- Diversify broadly
- Keep costs low
- Capture market returns
That usually means using a mix of stock and bond index funds.
5-Year Short Term Investment
If you have five years and it's not a huge deal if some of the money isn't there in 5 years and it would be really helpful to make 10% a year instead of 3% a year, then maybe you want to invest it quite aggressively in an 80% stock/20% bonds portfolio.
1-Year Short Term Investment
If it is for 1 year and you could afford a tiny loss but not much more and you'd like to try to get a couple of percent more than you can get in a CD, then maybe a conservative portfolio like 20% stocks and 80% bonds is appropriate.
When Any Loss Isn't an Option
If you cannot handle the loss of any of this money and it must be available on a specific date in one year or less, well, that's what high-yield, FDIC-insured savings accounts or a money market fund is for.
What you don't want to do is go gambling. You've got a 48.65% chance of doubling your money by just going down to Vegas and betting it all on red. (and a 24% chance of quadrupling it and a 12% chance of 8Xing it etc). Admit to yourself that you have no idea what Amazon stock or a Bitcoin will be worth in a year. At least your odds are known at the roulette table.
The OP wanted to get a “decent gain” but did not define that. If decent is 2%, well no risk need be taken. If decent means 10%, well, how much risk of loss are you willing to take to get that 10%?
What do you think? How do you invest short term money and why? Comment below!
What is the saying- ‘the best time to plant a tree is 20 years ago, the second best time is today.’ With the benefit of age and longer horizons our short term money is in CDs, laddered. So the money I need by this summer for the kid’s wedding will be, all else failing, from a CD maturing around then. As you follow the WCI philosophy of planning ahead, make beyond your TTJASI (take this job and… ie FIRE) fund and emergency fund a small and growing ‘we know we gotta buy another car/ fix the roof/ send Junior on spring break’ fund for 1-2-3-4-5 years down the road. I got my kids started on that track by having them buy laddered CDs with all their college pocket money, 1/8 of the total money per term, with graduation gifts and birthday money plus the mom/dad top off, so they don’t blow all their pocket money freshman year. Love it even more when the CD matures and the kid says ‘think I’ll renew that CD to mature for grad school/ after college’.
HI, a contributor from the forum recommended high quality timed corporate debt if you have set date for use of the funds.
https://www.whitecoatinvestor.com/forum/personal-finance-and-budgeting/181673-short-term-time-horizon-save-invest-or-speculate
Not to start a forum vs facebook argument, but I find the question and response of facebook threads to be alarming. Maybe I am just too old (late 30’s) for facebook. I feel that the question is somewhat naive (which is ok we all start somewhere) but the responses are even more misguided (although some could be in jest). Great articulation WCI on risk vs reward that is needed to address the question, which is essentially is there a short term investment with no risk and “descent gain”. I really appreciate the forum even more now.
What do you suggest be done about it?
Nothing really, just very thankful the forum exists for higher level questions and answers. I understand facebook likely has a broader and larger audience and appeals to younger physicians. I just hope advice like invest in narrow sector ETFs for short term investments aren’t listened too. Perhaps there are moderators or other people chiming in to combat this type of advice. Thanks for all that you do.
Yes, there are moderators and people chiming in, but they often feel outnumbered. It would help if others, like yourself perhaps, would chime in more frequently instead of just saying “the FB group gives bad advice.”
Thanks, made the decision to be off the grid from social media a few years ago. I have been happy with that decision, but I appreciate that you have moderators etc..
The two biggest problems with FB forums is there’s no context about the person replying and the speed with which questions and comments get buried below new questions. You can’t tell whether the advice comes from a highly experienced, savvy investor or a 25 YO working a minimum wage job with a seven year car loan. Everyone appears equal in the comments section.
FB just wasn’t designed for providing actionable advice in a back & forth context. The focus is generating new content as quickly as possible to maximize engagement which pushes threads off the bottom of the screen almost instantly on highly active forums. I gave up on FB forums for anything but entertainment and general trends after participating in several small business, entrepreneurship and personal finance Facebook groups after about two years. For anyone with experience (and likely different goals than many newbies), the dreck greatly overwhelmed the handful of useful response.
By far and away, the best Q&A online model for multiple anonymous participants is Stack Overflow.
Every response is rated by the community and contributors receive points based on the quality, speed and volume of answers. Moderators with enough points can edit questions, responses and comments along with redirecting questions to existing highly rated answers for the same question. It’s a fantastic way to quickly get the best answer(s) without wading through two dozen similar sets of questions.
Although it’s a free service, one notable downside is the service requires enough traffic and contributors to establish a new forum on a particular topic. It’s not a huge threshold and WCI along with the network partners might very well qualify.
And then I have to figure out how to teach tens of thousands of people who already know what Facebook is what Stack Overflow is. That’s not an insignificant bar.
In your late 30s, you’re more likely to be too young for Facebook these days
Both have their flaws. Seen the cussing, ranting and insults on forum lately?
I haven’t. I hope that’s because the moderators are getting to them before I do.
This is a great article! I’ve always had my emergency fund with 6 months worth of savings in a money market account. Certainly not the highest yielding investment but I know the money will be there if I need it. I’ve never been a big fan of CDs since I’ve found their return to be only slightly higher than a money market account and you have to sacrifice liquidity. There are two other places for short term money that I have been looking at lately. 1. T bills 2. Municipal Bond fund (short term/ low risk). As far as I can tell, both of these have some exemptions from taxes. Has anyone used these? What have your experiences been?
I use a muni bond fund when I buy bonds in taxable. If you keep the duration short you could use it for short term investing like any other short term bond fund. Never bought T bills directly, but again, a short term treasury fund or a treasury MMF would be quite similar.
For this reason I like the no penalty CDs with Ally. It’s liquid if I need it since there’s no penalty and get a bit more than standard high yield savings
I’m a huge fan of buying T-bills directly. Easy to buy with no fees through my brokerage account at weekly/monthly auctions depending on the duration. No state income tax, which boosts the yield, depending where you live. Currently yielding about 1.5%, so you buy them in $1,000 face value increments with the yield priced in. For example, a 1-year at 1.5 percent yield would cost ~$985, while a 13-week one would be $996, and a 1 month one would be a little under $999. Highly liquid, if you need the money before they come due. I’m no accountant or lawyer, but my understanding is that if you buy a 1-year one and hold to maturity, the interest isn’t taxable until your tax bill for the year it matures. So you pay $985 on 3/1/20, get $1,000 on 3/1/21, and then owe federal tax only on the $15 by 4/15/22.
No taxes are due on anything until 4/15 except insomuch as the estimated tax payment rules.
Basically by doing this you’re saving the expense ratio on a fund that would do it for you. I don’t think that’s worth it for me, but it’s not like it’s a huge effort to just buy them individually. Bernstein is a big fan of just buying treasuries directly.
The trivial benefit of buying a 1-year T-bill early in the calendar year is that even though the holding period may be 75% in 2020 and 25% in 2021, the interest is 100% applied to 2021’s tax bill, so if your tax bill on $15 is $4, then you get to pay all $4 with your 2021 taxes, rather than $3 with 2020 and $1 with 2021. Clearly, this is of smaller import than the savings in state income tax for most folks. Also, your point about really needing to withhold or pay estimated taxes as you earn money is well taken, but still, you’re shifting $3 in taxes ahead by 1 year.
That is a nice benefit to defer that tax.
| According to Vanguard, an investment in US stocks lost money in 25 out of 92 years between 1926 and 2017.
No doubt that’s true, but it’s certainly misleading to use the start/end of every calendar year for the analysis. I wonder what the analysis would show for all possible 365 day periods.
Has anyone seen a stock market return analysis that covers all the 12 month rolling periods since the early part of the century?
For sure. Lots of years have a 20% drop at some point during the year that doesn’t show up in the Jan 1-Jan1 results.
I do like Short term tax exempt bond and MM funds for their liquidity/ check writing . I have steered away from CD s b/ o taxable interest . ( I’m in 32 % marginal). Is this behavioral or meaningful? It seems that tax equivalent yields are similar.
Assuming this would just be in a taxable account, correct?
Most short term investing is done in a taxable account, yes. If you were 60+ you wouldn’t need to though.
Historically, the return of cash as an asset class is around the rate of inflation, and that doesn’t include taxes. However, the call option property of cash is not included in that return. If you had cash in March 2009 and used it to buy stocks, your return on that cash has been much greater than the inflation rate. When one talks about the option property of cash, one is really talking about cash used in a market timing strategy. And market timing is difficult at best. However, it would be something to consider if stock valuations were similar to those in the US in 1999 or Japan in 1989. In such rare circumstances, the ratio of the opportunity cost of being in cash to the value of the call option property of cash is more favorable.
Cash certainly hasn’t matched inflation in the last decade.
Knowing that, how do you handle your sink funds?
I am a soon to graduate cardiology fellow whose sink funds were so small never worth spreading it out from checking count. At what point and how do you invest money that’s allocated to sinking fund like that yearly ski trip as well as that dream heli ski trip in 5-10 years.
I leave it all in my high yield savings account right now, but at times it’s in a money market fund when those yields are higher. I just keep track of them on a spreadsheet.
I know index funds are great for long term investments, however, came across an article which I quote below in part, where to be honest, I do not know the answer. Can anyone help me understand where it is hopefully wrong?
“It’s “Very Much Like The 2008 Bubble”
Despite the spirited rally in stocks this week, Michael Burry sees a different outcome. He said the true valuation of the stock market is completely distorted by the trillions of dollars flowing through index funds. A total of 50 percent of stock allocations are now in passive funds.
In other words, Wall Street is no longer picking stocks based on rational, fundamental valuations. Instead, they’re allocating trillions to passive funds which track the entire market as one.”
There were a whole rash of articles that came out after Burry’s interview. You should probably read a few of them. Here’s one of them:
https://awealthofcommonsense.com/2019/09/debunking-the-silly-passive-is-a-bubble-myth/?utm_source=dlvr.it&utm_medium=facebook
I do like Short term tax exempt bond and MM funds for their liquidity/ check writing . I have steered away from CD s b/ o taxable interest .
This and the WCI article on the PSLF side fund have been very helpful to me. I work for the VA and am about to complete the last year of their Education Debt Reduction Program where they reimburse about 24K$ per year in student loan payments each year for 5 years. I have put that money/other savings into CDs at first then started reading your forum and some of the books on your recommended reading list. Now that I have 4.5-5 years until potential PSLF and rates being so low, I want to put the side fund into something a little more aggressive. I liked your recommendation to correlate the stock exposure of a PSLF Side Fund to how strong I trust/distrust PSLF. Although I have more belief that it will be around, I still have lingering doubts so my personal tolerance level is similar to a balanced fund like you suggest. If/when it is forgiven then some of that money maybe used for a house down payment, so I am okay being a little more conservative than 100% in VTI. Thank you, Dr. Dahle!
I appreciate this discussion and am inexperienced in short-term investing. I listened to recent PIMD and WCI podcasts that got me reconsidering my current emergency fund, now cash in a brokerage account and savings account. WCI talked about Short-term Bond Funds in the most recent speakpipe Q&A. I have a Fidelity Brokerage Account and became somewhat overwhelmed with their choices for STBF’s. This seems like a reasonable option for investing money I may (or may not) need in 6 months to 5 years. Any advice in how to narrow down these options? Thanks for all you and your team do!
A short term bond fund is only slightly higher risk than a money market fund for only slightly higher yield and a potentially slightly negative return. It’s certainly reasonable to put some of your emergency fund in there I suppose.
I’d probably keep it simple and use this one:
https://fundresearch.fidelity.com/mutual-funds/summary/31635V273
Thanks for the quick response and your suggestion for a fund to look into. I will certainly check this one out.