Long-term investing is suitable for retirement. But what about investing to fulfill short-term dreams -- like buying a new home, a new car, or saving for that once-in-a-lifetime dream vacation around the world? Certificates of deposit and money market accounts are the best way to save for short-term goals, and keep your principal intact.
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Most likely the handful of above-referenced people doesn't include you. It certainly doesn't include me! While I fantasize about trying my hand on the Millionaire show, I have nightmares of making a total jerk of myself by missing the $200 question -- the one that my 4-year-old niece could answer between drools. As for Survivor, one night in a sleeping bag taxes my limit. And the closest I'll get to Bill Gates is Windows 2000 tech support.
I will realize my dream of becoming a millionaire through a long-term investment portfolio. The first step on this journey for any investor is to get your financial house in order by paying off debts. Next, build a long-term portfolio consisting of a personally comfortable combination of index funds, Foolish Four stocks, Rule Makers, and Rule Breakers (for the high-risk crowd).
But, what about short-term dreams -- like buying a new home, a new car, or saving for that once-in-a-lifetime dream vacation around the world? Far too many investors who are saving for a goal they hope to reach within the next three to five years come to Fool.com looking for that magical mystery stock, or a mutual fund that will be "safe" and return upward of 20% per year.
First of all, no investment in the stock market is "safe." There are too many risks associated with investing in individual companies to make any investment in stocks guaranteed to have a huge return. By buying strong companies and holding them long-term, however, we're minimizing our risk by maximizing the time we allow the company to grow.
As for that 20% growth -- pardon me while I turn away for a snicker (and I don't mean the candy bar). It appears that the past few years of the raging bull market have colored some investors' expectations of what the stock market will return. Our goal at the Fool is to beat the S&P's long-term historical compounded average rate of return of 11%. Too many people forget that this is an "average" -- which means that some years will return significantly higher amounts and some years significantly lower ones.
If you're saving for a short-term goal, getting caught in one of those significantly lower periods of return may result in a significant loss of your principal. If you need the money soon, a loss of principal could be devastating. Therefore, investors seeking a safe harbor for a short-term investment have two basic options -- a certificate of deposit (CD) or a money market account.
With a certificate of deposit, you deposit your money with the bank for a specified period of time (three months, six months, one year, two years, etc.), and you receive a certificate for an interest-bearing instrument. The interest is paid at regular intervals, with each bank selecting its terms. When you redeem your CD, you receive the money you originally invested plus any accrued interest. The drawback to parking short-term funds in CDs is the penalty charged if you withdraw your funds early.
A CD with a "call" feature may have a higher rate of return. With a callable CD, the bank may terminate -- or call -- the CD after only one year. Only the issuing bank may do this, not the investor. A bank may call a high-yield CD if interest rates fall. If interest rates rise, you will be locked into the original, lower rate.
The other alternative for short-term cash-stashing is a money market fund, which is basically a mutual fund that buys securities such as Treasury bills, short-term commercial debt, and certificates of deposit. Because a money market account sticks to short-term, high-quality securities, it's relatively safe and liquid. You can open a checking account connected to your money market account, and there is no charge for withdrawing money. Yields vary according to short-term interest rates, and have been hovering in the 5-6% range. While money markets aren't attractive over the long-term, as they significantly underperform the 11% average return of the S&P 500, they're very attractive over the short-term because they won't take a bite out of your principal.
The best rates for CDs and money market funds can be found at bankrate.com. It's no problem if an out-of-state bank has a great rate. Just contact the bank, fill out the necessary paperwork, and send in your money.
If you're interested in money markets, consider opening an account with a discount broker. Most brokers offer free checking with a money market account, as long as you keep a minimum deposit. Their rates are often slightly higher than the banks'.
You don't need to be on Survivor to realize your dreams. But for your principal to survive short-term, park it safely in a zone where you're guaranteed that it won't be banished each week.
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