- Not all financial goals have the luxury of a long investing horizon.
- Strategize short-term investments according to risk, complexity and timing needs.
- The desire for stability is a key consideration when investing for shorter time periods.
When making investment decisions, one of the most critical elements to consider is your time horizon. Achieving short-term goals — defined here as three years or less — may require a different approach than long-term goals such as retirement or funding a child’s future education.
While many investments are designed to grow over extended periods of time, there may be occasions, such as saving for a down payment on a home, when there’s only a short window of time to reach a goal.
How to position investments for the short run
Even within a period of three years or less, your specific time horizon can provide guidance on the types of assets to consider as well as the appropriate levels of risk to take. For example, a portfolio with easily accessible cash investments may be more suitable if you need the money in three months, while someone who doesn’t need the money for three years may have the flexibility to consider a wider array of investment options.
Here are three guidelines to think about when investing over a short time horizon:
1. Determine your level of risk
Given such an abbreviated time period, it’s prudent to reduce the level of risk in an investment plan or portfolio. A business or market cycle usually lasts more than three years¹, so there typically isn’t enough time to recover from a loss that may occur if choosing higher risk assets such as equities.
To illustrate, a recent equity market correction occurred during the “dot.com” crash when the S&P 500 Index dropped over 35% from 2000-2002 and didn’t fully rebound until 2006.
The lesson learned here is that, with a maximum of three years to invest, investing in more volatile assets can lead to undesirable outcomes.
Reducing the complexity of assets may also be beneficial. For example, non-U.S. assets are exposed to foreign currency movements, which add a layer of uncertainty that doesn’t affect U.S. assets.
2. Consider short-term instruments
Cash is a desirable asset for managing risk and liquidity and is certainly appropriate for very short horizons. Within the fixed-income universe, securities with less than three years to maturity, such as short-term bond funds, may be a good consideration.
3. Synchronize goal timing with your assets
If your specific time horizon is known (for example, three months, 12 months or three years), invest in products that generally match your investment timeline. Consider these examples:
- If you’re saving for a down payment on a house that’s due in six months, look for products such as short-term government bonds or AAA-rated corporate debt bonds.
- If you have a down payment on a purchased item due in six months, with the remainder of the purchase price to be paid in 12 months, then look for products with varying durations of six to 12 months, such as a laddered certificate of deposit (CD).
Make sure your investment strategy works for you
Once your investment approach has been determined, there may be additional factors to be considered related to implementation depending on the products used. Your advisor can customize a plan that aligns with your short-term goals while factoring in a broader view of your overall investment strategy.