It's not often that we think of investing for short-term goals. Too often, that money sits in a cash account, earning meager interest.
A few months ago, I was in a position to make a fresh start with my life. As part of my overhaul, I also changed things up with my finances and created a travel fund.
I've long advocated the creation of a “fun fund” and I use a taxable investment account for my own fun fund. But I decided that I wanted to create another fund specifically aimed at travel. Because travel is one of my true pleasures in life, and I think my son could benefit from it as well, I want to make it a priority.
As is my regular procedure when investing for short-term goals (and long-term goals), I am using an indexing strategy.
My Travel Fund
I decided to use my Betterment account to open another “goal” to use as my travel fund. My Roth IRA is already at Betterment, so it was easy to set up another goal and direct some of my money toward that account. Unlike my retirement goal, which has a 90% stock/10% bond split, I am a little more conservative with the travel fund. My split in this case is 77% stock/23% bonds.
When investing for short-term goals, it's important to balance the desire to see good returns with the risk that you could lose some of the money. Because bonds are considered safer, boosting my allocation in that area seemed the thing to do. (Of course, an argument could be made that I should have a larger allocation to bonds.) So far I don't regret my decision, though. I've earned almost $20 since setting the goal in August, and as I move forward, my travel fund will continue to grow and result in more earnings that I can use to plan awesome trips with my son.
Indexing to Reduce Some of the Risk
One of the reasons that many consumers are shy of investing for short-term goals is due to the volatile nature of stocks, and concerns about stock picking. This is one of the reasons that I love indexing. There is no need to pick stocks when you index. Instead, you have exposure to a wider segment of the market. Rather than worrying about whether one security does well, you can take advantage of the entire market's performance.
Anyone who listens to me talk about beginning investing — or any type of investing — knows that I'm a hardcore indexer. Even with my short-term goals, I prefer indexing. Betterment takes care of that for me, investing in index ETFs designed to help me reach my goals.
In general, indexing is low-cost. I like Betterment because there are no transaction fees. Instead, a relatively low annual fee is charged based on my assets. You can use this strategy with other brokerages as well. One of the reasons I decided to go with Betterment on this one is due to the fact that I automatically have $200 put into this goal each month. I don't want to worry about a transaction fee for each ETF share I buy.
Indexing reduces some of the risk associated with stock investing, and if you invest in dividend index ETFs that can add another layer of returns with somewhat limited risk.
Watch Out for the Risks of Investing for Short-Term Goals
Of course, indexing won't eliminate the risk completely. You still have to be aware of the possibility of loss. Any investment comes with that risk. (And keeping your money in a cash account comes with the risk of inflation loss.)
The key to making investing for short-term goals is understanding what you can handle, and having a plan to deal with it. I know that, even if the market is down today (and it is), there is a good chance that it will rise over time. Plus, with the dividends involved, I'll probably come out ahead, barring some huge crash just before I decide I want to liquidate my assets and pay for a sweet trip.
Another consideration is what happens if you do lose out. I keep the bulk of my emergency fund in a taxable investment account as well. I use the “first in first out” method when selling shares so that most of what I sell counts as long-term capital gains.
The other possibility is that sometimes when I sell, I wind up with losses. In those instances, my loss is transformed into a tax deduction. If I decide to use the money in my taxable investment account to go on a Viking River Cruise in two years, chances are that I'll have a nice chunk of change to do so. Even if I end up with a loss overall, I'll probably still have sufficient capital. And I've made my vacation tax-deductible. If I sell and end up with gains, most of them will be long-term capital gains, taxed at a favorable rate.
There are always risks, but if you want a better chance of building your travel fund, and you can stomach it, a taxable account can make sense when investing for short-term goals.