If you’re saving for a down payment, a car, tuition, or a wedding within about five years, keep that money out of stocks. One bad year can erase a third of a stock portfolio, and the recovery can take longer than you have. Park it in cash-like savings, and invest only what can wait.
Say you and your partner have $40,000 in a stock index fund for a down payment you plan to make in two years, and the market drops 25% the year you go to buy.
The fund is now worth $30,000, so you either delay the purchase or buy with $10,000 less.
Long-term investors get through drops like that by waiting. Money with a deadline can’t. The S&P 500 lost 37% in 2008, and someone who had bought at the 2007 peak needed nearly five years to break even, dividends included.
Losses are also harder to undo than they look, since a 25% drop needs a 33% gain just to get back to even. A goal two years out can’t count on getting it in time.
Match where the money sits to when you’ll spend it. A high-yield savings account fits money you might need any day. For a fixed date, a CD that matures by then locks in its rate, and a CD ladder lets portions mature on a schedule. Treasury bills and government money market funds work too, and none of these move with the stock market.
Over time, all of these grow more slowly than stocks, which have returned about 10% a year since 1928 against about 3.4% for three-month Treasury bills, in NYU professor Aswath Damodaran’s data. But by our count of the same data, stocks did worse than the bills over about a quarter of all two-year stretches.
Start moving goal money you’ve already invested into savings about five years before you’ll spend it, or right away for a goal that’s closer. Shift it in steps, a quarter of the fund every three months, so one bad month can’t set the price for all of it.
Before you invest money for any goal, write down the date you’ll spend it. Keep the money in savings if that date is less than five years off.
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