I focus a lot on long term investing and equity when it comes to most of my posts. There is a very simple reason for this: I currently still have a long term investing horizon and equities offer one of the best returns over the long term. My portfolio consists of real estate, which I live in and also rent, and almost all the rest is held in equities.

The long term average rate of return on the S&P 500 index is about 10% annually or around 7% when you adjust for inflation. This type of return is usually only achieved by those who are able to buy and hold their funds or ETFs for many decades without wavering. It takes conviction, discipline and mental fortitude to invest in this way and even over the long term, people can get dismayed. We are likely coming to the end of a 10 year bull run in stocks, which frankly, us investors deserved for dealing with stocks falling off a cliff during the financial crisis. Although the past 10 years have seen 13% annual returns, there have been a number of decades with subpar returns as can be seen if we look back the last 70 years in terms of returns by decade:

Source: simplystockinvesting.com

Imagine those people who were buying equities in the mid 60’s, you had about 15 years of sorry returns to deal with until you saw the fantastic returns of the 80’s.

I would argue that this long term decline is exactly what gives equities their long term return. People get so disheartened after decades of subpar returns, that the market ceases to be a focus in terms of making money. Long term trends are hard to spot when you are looking at daily returns, so by the time everyone realizes we are in a rally, they’ve lost out on a ton of gains.

The investors in it for the long, long, run though, were there the whole time and even adding to their positions so when things take off, it’s like rocket fuel to their savings for the past few decades.

Back to the Topic

So now that you know why my focus is long term returns and staying invested, it is worth mentioning that there are more needs people have than just over the long term. Whether you are saving for some specific goal like a house or a vacation or you just have some money you may not need in the next 3 months, but may need in the next 6 to 9 months, it’s worth talking about short term investments.

I think the personal finance gurus you see on TV and read about have a pretty decent rule of thumb: save about 6 months of living expenses and keep it in cash just in case anything goes wrong like a job loss and you will have a strong cushion there so you are not immediately in a crisis if you lose your job. The rational here being that is takes about 6 months on average to find a job once unemployed so your savings can cover that period.

That’s where many of them leave you though and there’s a bit of a gap between the 5 years that many recommend to have as your minimum horizon for investing in the stock market and the 6 months worth of living expenses you have sitting around in cash. What about the money you may be saving for a house that you want in say, 3 years?

For these investments, I tend to take a graduated approach:

• From 6-12 months I may actually put the funds in a bank CD or money market fund. The CDs are guaranteed by the government regardless of the bank and may offer a bit higher return than treasury bills (short term government securities).
• From 12 to 24 month needs I put them in short term corporate bond funds. With these at least, they earn something more than cash, likely around 1.5% to 2.5%.
• Beyond 24 months I like to put my funds in what’s called a target risk strategy or Life Strategy Fund from Vanguard. I will explain these in more detail below.

6 to 12 Months

The Vanguard Prime Money Market Fund (VMMXX) currently yields 2.38% and is made up of short term corporate debt with maturity between 30 and 90 days and treasury bills. This is a new option for my portfolio because due to the low interest rates for many of the past few years, returns have been near zero as you can see below.

Source: Vanguard

Bank CDs are also an option for this time period but I don’t just choose one from my bank, rather I look up the best ones from sites that rank them like here. With the internet, I can easily open an online account and invest. Many banks require you to open an account to invest in their CDs. I am willing to deal with the hassle though. Once the term is up, I am more than happy to close shop and close my account, moving my money to the next best return. It’s also worth asking if you have a financial advisor, that if they can purchase other banks CDs directly on your behalf. The reason I do this is because the CDs are backed by the government so you may as well get the best rate you can.

12 to 24 Months

CDs can also be competitive over this range but there’s a big problem: CDs aren’t very liquid, you can’t just take the money and run when you need it. For this reason I prefer to invest over the 12 to 24 month time horizon in short term corporate bond funds. Obviously this will depend on rates and in another interest rate environment than the current one, I may be already investing in intermediate funds for this time horizon but since we currently have a yield curve inversion, short term rates are attractive.

Vanguard currently has a short term corporate bond fund (VFSTX) that meets this need and is yielding 2.56%. The last 10 year annual returns are below for this fund.

Source: Vanguard

Obviously, the returns are not stellar and not even guaranteed to beat a bank CD per day, but they do offer some upside in some years, at least to keep pace with inflation.

2 Years to 5 Years

Beyond 2 years, I like to start to add a little bit of equities but I mostly stick with intermediate term bonds. I really like the idea of the “all in one” fund from Vanguard which gives you different options depending on your time horizon, especially for beginning investors.

Source: Vanguard

I think most people would pick the first fund on the left for the 2 to 5 year period just because of the potential loss of principal if you go beyond the 20% that is in stocks, but I am a bit more aggressive so I tend to also include the conservative growth fund for 4 or 5 year horizon investments.

If you are curious to see what the annual returns are for those funds, the annual return for the previous 10 years of the LifeStrategy Income Fund (VASIX) is below:

Source: Vanguard

As for the Conservative Growth Fund (VSCGX):

Source: Vanguard

More upside in past years but also there is obviously more downside. Also take into account that the past 10 years have been a bull market in equities and we are at the point where 10 year returns no longer show those huge drops from 2008 and 2009 so the 10 year returns look a little too safe and rosy for what may be the reality for the near future.

The LifeStrategy Funds are essentially funds of funds, the underlying funds are also Vanguard funds and are balanced between domestic and international holdings. The breakdowns of the bonds versus equity allocations are shown below.

Source: Vanguard

Conclusion

Not the most exciting or groundbreaking stuff, but sometimes the best investments aren’t. The main goal that you want is to just avoid sitting a lot of funds in cash getting returns lower than inflation and eroding away your savings. In the past 10 years inflation has averaged about 1.6%. Whatever you keep in cash over time loses its value in terms of what you can purchase with it. This is why a return of 1.5% to 2.0% is my minimum return threshold for my short term investments. If you consider you may pay a third in taxes, that bumps up the minimum return required to 2.3% to 3%. This is why equities and bonds become important to keep up with inflation and not becoming poorer over the long term.

People often overlook the dividend factor too. Reinvested dividends account for 44% of that long term return of equities and lessen the overall blow of weak annual returns to the market on a capital appreciation basis. Always make sure your investments in all your brokerage funds are on an automatic reinvestment program. It puts your returns on auto drive and is crucial for maintaining those long term returns.

I encourage readers to investigate these options and if you are aware of better ones out there please feel free to share.

The information provided by www.cashchronicles.com is for informational purposes only. It should not be considered legal or financial advice. You should consult with an attorney or other professional to determine what may be best for your individual needs. www.cashchronicles.com does not make any guarantee or other promise as to any results that may be obtained from using our content. No one should make any tax or investment decision without first consulting his or her own financial advisor or accountant and conducting his or her own research and due diligence. To the maximum extent permitted by law, www.cashchronicles.com disclaims any and all liability in the event any information, commentary, analysis, opinions, advice and/or recommendations prove to be inaccurate, incomplete or unreliable, or result in any investment or other losses. Content contained on or made available through the website is not intended to and does not constitute legal advice or investment advice and no attorney-client relationship is formed. Your use of the information on the website or materials linked from the Web is at your own risk.