Investing For Intermediate-Term Goals

April 29th, 2008 · No Comments · Subscribe to this feed

As Hannah at The Penny Mine noted recently, most people are pretty bad at planning for intermediate-term goals. Sure, these people will spend countless hours researching mutual funds for their IRA and call 15 banks in their area getting rate quotes on 6 month CDs, but when it comes to a new car fund for a purchase 7 years out, planning seems to go out the window. Maybe it’s just that intermediate-term goals are harder to quantify. How do you know how much you need to save for a new car if you don’t even know what kind of car you’ll need in 7 years? More likely, though, it’s just that investing for intermediate-terms goals is so difficult. Here are a few things to consider when investing for intermediate-term goals, which I’ll define as goals 5-10 years out.

How Critical Is It For Me To Reach My Target?

The first thing you need to determine is how important it is for you to hit your target. Can you afford to fall short? Here’s a personal example: I am saving up to buy a new car in 6-7 years. I already have a few thousand saved up and save an additional $100 every month towards my goal saving $15,000, which I figure will buy me a decent-quality late-model used car by then. However, if something goes wrong and I fall short of my goal by a few thousand dollars, it’s not the end of the world. I can either put off buying a new car for another year, buy a cheaper model, or just take the balance out of my emergency fund (not recommended, but it’s nice to have that sort of flexibility). Since it’s not such a big deal if I fall a little short of my goal, I can afford to invest a bit more aggressively than I otherwise could. To that end, I’ve invested my car fund in Vanguard STAR (VGSTX), which invests 60% of its assets in stocks(including a significant stake in foreign equities) and the balance in bonds. Yes, it’s a little aggressive. Yes, there is a very real chance the fund could take a dive just before I need the money. But that’s ok. Even in the worst-case scenario where STAR loses 15% in the month before I buy my car (STAR lost a bit less than 10% in the tech bust, so 15% is very realistic), I’ll still be fine. I can just buy a cheaper car and write the loss off on my taxes next year as a consolation prize.

For goals you can’t afford to miss, such as the first year of your daughter’s college tuition, you have to be a bit more strategic. If you take too much risk and take a loss, it’s unreasonable to ask your daughter to put off college for a few years while you save up more money. If you try, she’ll probably run off and marry a circus performer in Vegas, and I know that’s the last thing you want. For goals like that, an intermediate-term bond fund (such as Vanguard’s Total Bond Market Index Fund) is probably the best choice. Just be sure to match the effective duration of the bond fund with your expected time horizon: that is, don’t buy 20 year bonds for a goal 5 years away.