3 tips for short-term investing
Joe Wong, Asset Allocation Director, Ameriprise Financial
- Not all financial goals have the luxury of time
- Streamline short-term investment strategies related to risk, complexity and timing needs
- The desire for stability is paramount when investing for short lengths of time
An investor’s time horizon is a critical element to consider when looking at how to put money to work. Investing for short-term needs (where short-term is defined as three years or less) requires a different approach than when investing for long-term goals, such as retirement or a child’s future education. While most investment plans are designed to grow an investor’s wealth over extended periods of time, there may be occasions, like saving for the down payment on a house, when there is only a short window of time to reach a goal.
How to position money for the short run
Even within a period of three years or less, an investor’s specific 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 mostly cash investments may be suitable for a person who needs the money in three months, while a person who doesn’t need the money for three years may have the flexibility to consider broader investment options.
Here are three guidelines to think about when investing over a short time horizon.
1. Focus on reducing risk, and simplify
Given such an abbreviated time period, it is 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, let’s take a look at a recent equity market correction – the “dot-com” crash of 2000-2002. The S&P 500 Index had an actual starting value of 1,425.59 on 1/1/2000 and ended at 895.84 on 1/1/2003, reflecting a loss of 63%. From this point on, it would take almost four more years to recuperate its initial value. The S&P 500 Index had reached a value of 1,424.16 on 1/1/2007.
While the period used showcases one of the more prominent examples of a market correction, the lesson learned here is that, with a maximum of three years to invest, investing in more volatile assets like equities 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 for example, may be a good consideration.
3. Synchronize goal timing with your assets
If your specific horizon is known (e.g., three months, 12 months, or three years), invest in products that generally match your investment horizon. Consider these examples:
- If you’re saving for a down payment on a house that’s due in six months, look for products with a six-month duration.
- 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 twelve months, then look for products with varying durations of six to twelve months.
Make sure your investment strategy works for you
Once your investment plan has been finalized, there are some additional factors related to implementation that need to be considered, depending on the investment 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.