Conventional wisdom dictates that money needed in five years or less should be kept out of risky assets like stocks. If you’re saving for a major purchase like a house or a dream vacation, the last thing you want is a sudden bear market swallowing a chunk of your principal.
But leaving that money in a checking account runs the risk of it getting spent on other things. Where can you safely park the funds and still accrue a little interest?
Financial advisors say you have a few options, although none have great returns. Low yield is part of the trade-off for a safe investment, but you may be able to squeeze out a little more interest depending on how soon you expect to need the money.
[See: 7 Historic Bear Markets.]
The safe choice for super short-term needs. Dave Geibel, managing director and senior vice president at Univest Wealth Management in King of Prussia, Pennsylvania, says for clients who needed a place to keep money for a year or 18 months, “I would absolutely send them on the CD or bank route.”
Unsexy as it is, a traditional certificate of deposit is the safest place to park your money. Online banks can offer slightly higher yields on CDs or money market accounts than a local bank branch, he says.
“We always tell our clients to surf the web,” as long as the bank is federally insured, Geibel says. “Several online banks, like Capital One, can provide an online money market account that’s going to generally be better than something you might get out of your local bank.”
Still, because interest rates are rising now that the Federal Reserve is tightening monetary policy, it wouldn’t hurt to ask your local bank branch for a higher yield on a money market account, Geibel says. “You can say, ‘Hey, I’m going to build up the cash balance over a few years, what could you offer me?'” he suggests. The response you get “depends on the bank and on whether the bank needs deposits.”
Geibel and Joe Heider, president and founder of Cirrus Wealth Management in Cleveland, both recommend laddering CDs, or buying them at varying maturities. With a two-year time frame, the money could be deposited equally in several CDs with different maturities starting at three months and going up to two years. When the first CD matures, reinvest the funds, targeting the date you need the money. By laddering the CDs, you can also take advantage of rising interest rates.
Bonds and bond funds for the less short term. Another option is a short-term bond exchange-traded fund or mutual fund, says Mike Piershale, president of Piershale Financial Group in Crystal Lake, Illinois. One fund he uses is the Lord Abbett Short Duration Income Fund (ticker: LALDX).
Piershale says more than 80 percent of the bond fund’s holdings are rated triple-A, double-A or single-A, making them safe investments, and the money is spread out over about 200 bonds. “It’s a pretty conservative, safe thing to do,” he says. “If you went into something like that right now, the five-year average returns on it are probably around 2 percent, which doesn’t set the world on fire.”
[See: 7 Bond Funds to Buy as Rates Rise.]
He also notes there’s little downside risk because the average bond duration is only about two-and-a-half to three years. “When the average maturity of the bond is that short, [the price] doesn’t fluctuate much,” he says.
Heider, who also likes ultra-short-term bond funds as an alternative for short-term cash, notes they are easy to sell when you need the money. “If you’re saving for a car, it probably means your car is on its last legs,” Heider says. “The time frame could be variable, and if that’s the case, you need to have something that is readily converted to cash without penalty.”
Financial advisors also can ladder bonds for you using maturities of one to five years, Heider says, which he prefers rather than buying a bond mutual fund or ETF. The problem with funds, even those that ladder bonds, is that the share price still goes up or down on a daily basis, he says.
More aggressive investors could take some, not all, of the principal and put it in a floating-rate fund, Piershale says, but that’s not his first choice for short-term savings.
Piershale says floating-rate funds, which pay a variable rate, are less sensitive to changes in interest rates. He has used Eaton Vance Floating Rate Fund ( EVBLX), but here too, there are trade-offs.
“You do get a higher level of income when rates start going up because it’s a short-term variable rate,” he says. “Problem is it’s more risky because most of the bonds in a floating-rate fund don’t even have a rating. These also got clobbered in 2008.”
A balanced mix when you have a few years. If you really don’t need the money for four or five years, financial advisors say a conservative mix of some stocks and bonds could work for some investors. “If you look at most balanced funds, very few have ever had negative returns at a five-year period,” Piershale says.
This choice, however, only works for someone who is willing to take that risk. “There’s a possibility they could have a year where they get clobbered,” he says. “But it’s a limited risk. You may end up having kind of a flat rate of return; you could also end up making 6 or 7 percent instead of 1 or 2 percent.”
[See: 7 ETFs for Income Investors to Play It Safe.]
Heider says for someone willing to take on a small amount of risk, he might put 20 percent of a portfolio in high-quality dividend-paying stocks and the rest in CDs or laddered bonds. “Five years will give you some upside potential and also enough time that you should have an opportunity to make some money,” he says.
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Best Places to Park Money You May Need Soon originally appeared on usnews.com
