your financial details.
Setting priorities in the process of creating a solid financial position can be challenging. The financial planning pyramid provides a visual explanation and reminder to help people make the right moves at the right time. It aims to keep people from taking inappropriate risk by gauging the relationship between risk and reward. The pyramid also takes into consideration the element of time as a person makes progress towards his or her financial goals. It is a simple way to suggest how much of a person’s assets he or she should commit to different investments and other financial products.
Deciding how to allocate your financial assets and when to do so is something a financial advisor can offer invaluable advice on.
Levels of a Financial Planning Pyramid
There’s no single version of the financial planning pyramid. Some varieties have just a few levels and others have several. Some describe a wide variety of specific investments, asset classes and financial products and others just a handful of broad categories.
A core element of all versions of the pyramid is that the least risky financial moves are at the bottom, while the riskiest ones are at the top. The width of the pyramid at the level where a financial product appears suggests how important it is and how much of a person’s assets should be committed to it.
Here are levels of the financial planning pyramid:
Level 1 – The lowest level is the widest, which indicates its importance and where it should be in terms of priorities. It is also the least risky and, in fact, focuses on reducing financial risk. This level includes automobile, home, life, health, disability and liability insurance.
Level 2 – Once the first level is addressed, people can concern themselves with the second level. This level is focused on emergency savings. It includes money put into safe investments such as federally insured bank checking and savings accounts, certificates of deposit and government bonds.
Level 3 – The third level consists of savings and investment vehicles that may pay better interest rates than the very safe ones in the second level, at the cost of somewhat greater risk. They include money market accounts and high-grade municipal and corporate bonds and bond funds.
Level 4 – At the fourth level investments in equities begin to appear. These take the form of balanced mutual funds and high-grade shares of preferred stock and convertible bonds.
Level 5 – The fifth level consists of shares of blue-chip public companies as well as investments in growth-oriented mutual funds and real estate.
Level 6 – The sixth level represents investments in collectibles, speculative stocks and lower-grade bonds and mutual funds.
Level 7 – At the very top of the pyramid is a narrow wedge representing the small amount of assets that may be prudently committed to highly speculative investments. These could include commodities, over-the-counter penny stocks and the like.
The main idea of the financial pyramid that the width of pyramid at a given level expresses how much a person might wisely commit to the investments in that level. That is, more of a portfolio should ordinarily be invested in blue chip common stocks than speculative penny stocks. Time is also a factor. This means people are advised take care of the risk-management tools in the first level before starting to build emergency savings or begin investing in the stock market.
Different investors have different situations, which can affect the pyramid. For instance, a person in the middle of his or her career may be more heavily invested in growth mutual funds than someone approaching retirement, who would likely emphasize safety of principal with investments in high-grade bond funds.
Some versions of the financial planning pyramid have an even lower level. This may include the creation of a financial plan. Another item sometimes included as part of the lowest level is a budget that aims to make sure a person has cash left at the end of the month to stock an emergency fund and, ultimately, invest.
While financial products at the bottom of the pyramid are lower risk than those on higher levels, there is no risk-free investment. Even government bonds may generate a negative return in terms of buying power if the return does not keep up with inflation. There is also a risk of paying insurance premiums without ever making a claim on the coverage benefits.
The financial planning pyramid is a road map to help people decide where to put their emphasis today in preparing to reach their ultimate financial goals. It is a reminder of the relationship between higher risk and higher reward, and helps to ensure that people have the building blocks of a solid financial foundation in place before chasing better returns with riskier investments. While financial products at the bottom of the pyramid are lower risk than those on higher levels, there is no riskless investment. Even government bonds may generate a negative return in terms of buying power if the return does not keep up with inflation. There is also a risk of paying insurance premiums without ever making a claim on the coverage benefits.
Tips for Investing
- If making and implementing a financial plan seems like a complicated challenge, consider working with an experienced financial advisor. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
- Once you’ve decided to start investing your money, you’ll have to decide on an asset allocation that’s appropriate for your goals, age and risk tolerance. And unless you invest in a target date fund that automatically adjusts that asset allocation, you’ll have to rebalance your assets over the course of your investing time frame. That’s where a free, easy to use asset allocation calculator can be extremely helpful.
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For many, knowing where to invest their money can be nerve-wracking, especially if it’s in a long-term account that they can’t immediately access without facing fees or penalties. Fortunately, there are a variety of short-term investments that you can consider to grow your wealth and withdraw from in a shorter period of time.
Knowing what the best short-term investments are is hard, as it depends on current market conditions and your own financial goals. Today, short-term investments are even more challenging to understand as the COVID-19 pandemic is causing market conditions to fluctuate. However, there are a variety of short-term investments worth considering. Below, we’ll cover short-term investment examples throughout this post to give you a greater understanding of your options.
Read end-to-end to explore what short-term investments are available to you, or browse different short-term investments using the links below.
What Are Short-Term Investments?
You’ve probably heard the term thrown around here and there, but what are short-term investments? The short-term investment definition considers short-term investments, also referred to as temporary investments or marketable securities, as investments that can produce returns quickly, usually in 5 years or less.
People may place their money in short-term investment vehicles if they need their money to grow by a certain time. Unlike long-term investments like stocks and mutual funds that are riskier and can drop in price from bear markets, short-term investments are often safer, as the risk of losing gains is often lower.
There are a few reasons why someone may want to invest in short-term securities. For example, if you’re planning your wedding or hoping to place a down payment on a new home, you might consider short-term investments to grow your money and have access to it in a shorter period of time.
Another reason someone may become a short-term investor is because they want to take advantage of rising interest rates within a short period of time. While this strategy can be difficult, those knowledgeable on short-term investing can earn profits off of their marketable securities.
Common types of short-term investments include savings accounts, money market accounts, certificates of deposit (CDs), Treasuries, bond funds, peer-to-peer lending. In the next section, you’ll learn more about each of these types of short-term investments.
Types of Short-Term Investments
There are numerous short-term investments you can place your money in with hopes of gaining a return. Knowing how to start investing can be confusing, especially if it’s your first time and you know little about different types of investment vehicles. Below, we’ll cover some of the best short-term investments you may want to consider in 2020.
1. Savings Accounts
When you get paid, you most likely place your earnings in a bank account. There are two main types of bank accounts: checking and savings. Checking accounts are great for everyday spending, as you can withdraw funds for bills, groceries, and other transactions whenever you please. This is because checking accounts usually earn little to no interest.
Savings accounts, on the other hand, can earn interest. There are plenty of savings accounts where you can store your money, and one option is a high-yield savings account. High-yield savings accounts often offer high interest rates, which can earn you money over time. However, they usually place limits on how many withdrawals you can make each month – usually six. Savings accounts are FDIC-insured up to $250,000, which will protect your money in the event of a market collapse.
If you have robust savings or an emergency fund sitting around in a checking account earning no interest that you don’t plan on withdrawing from in the near future, you may want to consider placing your money in a savings account. Doing so can earn you more money in interest each month.
2. Money Market Accounts
A money market account is a high-interest earning account that typically pays a higher rate than a traditional savings account. However, these accounts often require a minimum investment, which means you may have to put down a sizable chunk of your savings to open one of these accounts. Money market accounts, similar to checking accounts, saving accounts, and CDs are FDIC-insured up to $250,000.
It’s important not to confuse money market accounts with their riskier counterpart, money market mutual funds. Money market mutual funds, which are not FDIC-insured, invest in debts and short-term maturities of less than one year.
Certificates of deposit (CDs) are a savings instrument that lock your funds for a fixed period of time. While locked, the bank or financial institution that offers your CD will pay a fixed-rate interest for the duration of the CD. Typically, the longer your CD term, the higher the interest rate you’ll receive. CDs typically offer higher interest rates compared to savings accounts and money market accounts. You can choose terms that can range from 7 days up to ten years. However, the most common CD terms are six months, one year, or five years.
When you open a CD, you typically agree to keep your money held in the account for the specified amount of time. If you withdraw money from your CD before it matures, you can face an early withdrawal fee or have to forfeit a portion of the interest you earned. Another drawback is if you tie your money up in a CD, you can risk missing out on another opportunity that offers a higher rate.
The U.S. Treasury offers a variety of securities you can invest in and grow your money. Some of the most common treasuries include:
- Treasury Notes (T-Notes): Issued with maturities of 2, 3, 5, 7, and 10 years and pay interest every six months
- Treasury Bills (T-Bills): Short-term securities that are sold as a discount from their face value and have maturities that range from a few days to 52 weeks
- Treasury Bonds (T-Bonds): Long-term investments that pay interest every six months and mature in 20 or 30 years
- Floating-Rate Notes (FRNs): Issued for a term of 2 years with interest being paid quarterly, with interest payments rising and falling based on discount rates for 13-week Treasury bills
- Treasury Inflation-Protected Securities (TIPS): Marketable securities with maturities of 5, 10, ad 30 years with interest being paid every six months with the principal adjusting by changes in the Consumer Price Index
Besides Treasury Bonds, these Treasuries are all backed by the U.S. government and are short-term investments worth considering.
5. Bond Funds
Bond funds invest in a pool of bonds, such as corporate, municipal, and government savings bonds. Ultra-short bond funds are similar to mutual funds. However, instead of investing in a pool of stocks, they’re investing in a pool of bonds with short durations.
In short, a bond is a loan to a government or business that pays back a fixed rate of return. They are generally safer than stocks, but still pose risks, such as a borrower defaulting.
When it comes to bond funds, you might want to consider investing in ones that primarily own government bonds. This is because government bonds are usually less risky than corporate bonds and have a lower chance of defaulting because they’re backed by the government. Bond funds are a viable option if you’re looking for a short-term high-yield investment. Additionally, you most likely won’t face a penalty if you withdraw early.
6. Peer-to-Peer Lending
Peer-to-peer lending, or P2P lending, is an avenue for small businesses and individuals to access capital through the internet. P2P lending is similar to taking a loan out from a bank, but comes from a peer instead, such as your neighbor, family member, or friend.
To get started in peer-to-peer lending, you first need to join a lending platform and decide what types of loans you’ll offer and the risk you’re willing to accept. From there, you’ll be able to pick and choose borrowers based on their creditworthiness and begin making money through interest.
With P2P lending, you can often yield greater results compared to savings or CDs. However, a drawback is that P2P lending isn’t FDIC-insured, which means it can be a risky investment if the borrower defaults and can’t pay back your loan.
7. Roth IRAs
Saving for retirement is a common goal for many individuals. One way to save for retirement is with an individual retirement account, such as a Roth IRA. While the initial purpose of a Roth IRA is to save for retirement, it can be used as a short-term investment. Unlike a traditional IRA, Roth IRAs allow you to make withdrawals without facing a penalty or having to pay taxes on your contributions. Any gains, however, can face taxes and penalties if you withdraw early.
Investment Options for Short-Term Money
There are numerous investment options for short-term money at your disposal. You don’t want to fall victim to common investment mistakes like buying a security without doing your research. Refer to the chart below to view a side-by-side comparison of common short-term investments.
Key Takeaways on Short-Term Investments
If you’re looking to grow your money in a short amount of time, short-term investments might be the option for you. Here are some key takeaways on short-term investments:
- Short-term investments are investments that can produce returns quickly, typically in five years or less.
- There are numerous short-term investment examples, such as savings accounts, money market accounts, CDs, Treasuries, bond funds, peer-to-peer lending, and Roth IRAs.
- The best short-term investments are those that match your financial goals. It’s important to do your research to find a short-term investment that works for you.
FDIC | Investor.gov; Certificates of Deposit | U.S. Treasury | U.S. Bureau of Labor Statistics | Investor.gov; Ultra-Short Bond Funds |
In the past couple of years I’ve written about quite a few startups that are offering easy ways to save and invest.
As I was doing some research on several microsavings sites, companies that allow you to save and invest small amounts of money based on your spending or other triggers, I found Acorns.
Acorns is a company that allows you to invest your hard earned money in small micro “round-up transactions”, with the idea that over time your small investments of $0.50 cents here and $0.35 cents there, will lead to a much larger retirement account in the end.
Here’s a review of Acorns, and a look at how they can help you to pad your retirement bottom line.
Acorns was founded in 2012 by Jeff Cruttenden and his father Walter as a way for first time investors to invest in a diversified portfolio. After receiving all of the regulatory approvals, they launched the app on July 15, 2014, and have been helping new investors get in the market ever since. Here are the details from Wikipedia:
Acorns was founded by Jeff Cruttenden and his father, Walter Cruttenden in 2012. Walter was an investment banker and had previously founded and served as CEO of Roth Capital Partners and e-offering, an investment banking firm. Jeffrey with his father worked on creating a mobile app for first-time investors to invest small automated investments from a bank account into diversified portfolios.Within less than two years of launch, Acorns opened nearly 1 million investment accounts. Acorns Grow Inc. is the parent of Acorns Securities LLC, a member of FINRA and SIPC, and Acorns Advisers LLC, an SEC registered investment adviser.
Acorns has over 4.5 million customers and over $1.2 billion in assets under management as of early 2019. So they’re growing at a good clip, and look to continue that as an attractive option for newer or beginning investors.
How Does Acorns Work?
Acorns is a micro-saving and investing platform that is mainly accessed via a mobile phone app, and via their website. They have three main tools.
Acorns Invest, a taxable investment account.
Acorns Later, a retirement account.
Acorns Spend, a checking account and associated debit card that helps you to save more.
To get started you just sign up for an account, link your checking account and after verifying the account – you can start saving and investing money automatically, without any need for you to intervene.
3 Ways To Save & Invest
Once your account is all setup there are 3 different ways that you can save and invest.
- Round-up savings: First, Acorns can save small amounts of money by rounding up your transactions in your main spending account. So if you spend $4.75 at McDonald’s, Acorns will round the transaction up to $5 and deposit $0.25 into your Acorns round-up balance. Once your round-up balance is at least $5, the money is withdrawn from your linked checking and added to your Acorns investment account.
- Scheduled deposits: You can save recurring amounts to Acorns on a scheduled daily, weekly or monthly basis. Just set the deposit amount, choose the frequency, and forget it.
- One time deposits: You can make one time lump sum deposits as well. So if you have $2000 you want to invest in Acorns, you can transfer that over whenever you want.
Acorns Investment Portfolios
The Acorns portfolios mainly invest in ETF index funds and were put together with the main input coming from Dr. Harry Markowitz, a Nobel Prize winner. He is commonly referred to as the father of modern portfolio theory.
Dr. Markowitz came on as a paid adviser in the early days of Acorns, and helped them to design good long term investing portfolios based on modern portfolio theory. They also take into account user input to questions in regards to net worth, yearly income, reasons for investing and time horizons – among other things.
When signing up there are 5 portfolios that you can choose from:
- Conservative: 35% Stocks, 60% Bonds, 5% Real Estate
- Moderately Conservative: 45% Stocks, 45% Bonds, 10% Real Estate
- Moderate: 60% Stocks, 30% Bonds, 10% Real Estate
- Moderately Aggressive:75% Stocks, 15% Bonds, 10% Real Estate
- Aggressive: 90% Stocks, 0% Bonds, 10% Real Estate
As of 2019, the following low cost investments are in the portfolios:
- Vanguard S&P 500 Index ETF (VOO)
- Vanguard Small Cap Index ETF (VB)
- Vanguard Emerging Markets FTSE Index ETF (VWO)
- Vanguard FTSE Developed Markets ETF (VEA)
- Vanguard REIT ETF (VNQ)
- BlackRock iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)
- BlackRock iShares 1-3 Treasury Bond ETF (SHY)
The investments are mainly low cost Vanguard and IShares index fund ETFs, bond funds, and a real estate ETF to further diversify. The investments are meant to capture the market, and keep fees low, focusing on long term growth.
Investments can change over time, so check for current investments when you sign up.
Acorns Account Types
When you sign up for Acorns, there are three different account types that you can sign up for. We’ll take a brief look at them here.
Acorns Invest is the original micro-investing taxable investment account that Acorns launched with in 2014. It takes only 5 minutes to setup an account and start investing.
The account allows you to invest your spare change in a diversified portfolio. More than $1 billion has already been invested here. This account costs $1/month.
Acorns Later is Acorn’s retirement accounts. They’ll recommend an IRA account that fits your goals. That could be a traditional IRA, a Roth IRA or SEP IRA.
Once your IRA is setup and your portfolio is chosen, you can setup recurring contributions, and invest.
An Acorns Later + Acorns Invest account is $3/month.
The Acorns Spend account is a checking account with no account fees, reimbursed ATM fees and ways to earn cash bonuses that can be invested. You’ll also get an Acorns Visa debit card.
When you get an Acorns Spend account you’ll also get the Acorns Later + Acorns Invest accounts as well. All three together cost $5/month.
Opening An Account With Acorns
Opening an account with Acorns is simple, but it is currently only available for U.S. citizens over the age of 18.
To sign up just go through this simple process:
- Go to Acorns.com via this link.
- Enter an email address and password.
- Connect your main spending account. (where they’ll track spending for round-up savings)
- Connect your checking account (where deposits are funded from)
- Create your investment account (taxable accounts only currently), including entering name, address, phone and birth date.
- Enter your Social Security Number for ID verification, tax reporting and fraud prevention purposes.
- Enter net worth, yearly income and your reason for investing. These are standard questions and will be used to help create your portfolio.
- Choose your portfolio. Choose the recommendation or choose one of the other 4 portfolios mentioned above.
After you verify your accounts you’ll be set to start saving and investing money automatically by round-up savings, recurring deposits or one time deposits.
Other Features of Acorns
Acorns has added other features over the last couple of years.
The Found Money section on the Acorns app allows you to shop at Acorns partner sites like Jet.com, Blue Apron, Airbnb, Apple, Hulu and others to be rewarded with cash back when you use a linked payment method.
So for example, if you book with Airbnb via the Acorns app and use your linked card, they’ll invest up to 1.8% of your service fee in your Acorns account. Buy something from Apple via the app? You’ll get 1.2% back to invest.
It’s an interesting way to save and invest a little extra by doing things you might have done anyway. It’s not going to make a huge difference, but if you were going to buy something anyway it’s a nice bonus.
Grow Magazine – Educational Content
Acorns publishes an online personal finance magazine that is geared towards millennials with advice on side hustles, credit card debt, student loans, investing (obviously) and other financial topics.
The content also appears in the app, so it’s always at the tip of your fingers.
Acorns Service Fees And Minimums
Where the rubber meets the road is just how much you’ll be paying to use Acorns. What are the fees and minimums for using the service?
First of all, there are no minimums in order to have an account, and you only need $5 to invest in one of Acorn’s five pre-built portfolios. So the service is accessible to just about everyone. There are no trading fees either.
Free For Students
If you’re a student who registers for the service with a .edu email address, you’ll be eligible to receive up to 4 years of free service with Acorns.
Since young first time investors are their target market, that makes some sense. If you’re a student, why wouldn’t you jump in on a great deal like this?
Low Monthly Management Fees
For non-students, you’ll pay $1/month when you start investing with Acorns Invest.
When your account balance is over $5000, you’ll pay a 0.25% annual management fee , There used to be a 0.25% annual management fee for accounts over $5,000, but as of 2018 all accounts now pay $1/month for Acorns Invest product.
If you add on Acorns Later retirement accounts, or Later + Spend checking account it will be $3/month or $5/month respectively.
- Acorns Lite: $1/month.
- Acorns Personal: $3/month.
- Acorns Family: $5/month.
The pricing is simple and easy to understand. No surprises. You just pay $1, $3, or $5.
Automated Micro-Saving & Investing
I’m a big fan of all the automated saving and investing services that have popped up in the past few years. My belief is that the more automatic you can make saving investing, the more likely most people are to plan for their future and put their future first.
I love the fact that Acorns invests for the long term with an investing strategy based on Modern Portfolio theory. If you’re a student, it’s a no brainer to sign up since you can get up to 4 years of the service for free.
For others, the fees charged for the service are in line with similar robo-advisors. The only caveats to my hearty recommendation are the facts that there may be cheaper options for those with extremely low account balances. The faster your balance grows, the less of an issue that becomes.
I’d also love to see them add some retirement account options in the future as they currently only provide taxable accounts.
All in all Acorns is a great service that can help make investing easier – and more automatic. They’re one of the best microsavings and investing sites out there, and I’d recommend checking it out.
Sign Up For Acorns Today!
Ease of use
- Easy way to save
- Makes investing simple
- Only need $5 to invest
- Free for students
- Proven long term strategy
- Fee percentage for low account balances
- No retirement accounts
your financial details.
An employer-sponsored 401(k) plan may be an important part of your financial plan for retirement. Between tax-deferred growth, tax-deductible contributions and the opportunity to take advantage of employer matching contributions, a 401(k) can be a useful tool for investing long term. Managing those investments wisely means keeping an eye on market movements. When a bear market sets in, you may be tempted to make a flight to safety with bonds or other conservative investments. If you’re asking yourself, “Should I move my 401(k) to bonds?” consider the potential pros and cons of making such a move. Also, consider talking with a financial advisor about what the wisest move in your portfolio would be.
Bonds and the Bear Market
Bear markets are characterized by a 20% or more decline in stock prices. There are different factors that can trigger a bear market, but generally they’re typically preceded by economic uncertainty or a slowdown in economic activity. For example, the most recent sustained bear market lasted from 2007 to 2009 as the U.S. economy experienced a financial crisis and subsequent recession.
During a bear market environment, bonds are typically viewed as safe investments. That’s because when stock prices fall, bond prices tend to rise. When a bear market goes hand in hand with a recession, it’s typical to see bond prices increasing and yields falling just before the recession reaches its deepest point. Bond prices also move in relation to interest rates, so if rates fall as they often do in a recession, then bond prices rise.
While bonds and bond funds are not 100% risk-free investments, they can generally offer more stability to investors during periods of market volatility. Shifting more of a portfolio’s allocation to bonds and cash investments may offer a sense of security for investors who are heavily invested in stocks when a period of extended volatility sets in.
Should I Move My 401(k) to Bonds?
Whether it makes sense to move assets in your 401(k) away from mutual funds, target-date funds or exchange-traded funds (ETF) and toward bonds can depend on several factors. Specifically, those include:
- Years left to retirement (time horizon)
- Risk tolerance
- Total 401(k) asset allocation
- 401(k) balance
- Where else you’ve invested money
- How long you expect a stock market downturn to last
First, consider your age. Generally, the younger you are, the more risk you can afford to take with your 401(k) or other investments. That’s because you have a longer window of time to recover from downturns, including bear markets, recessions or even market corrections.
If you’re still in your 20s, 30s or even 40s, a shift toward bonds and away from stocks may be premature. The more time you keep your money in growth investments, such as stocks, the more wealth you may be able to build leading up to retirement. Given that the average bear market since World War II has lasted 14 months, moving assets in your 401(k) to bonds could actually cost you money if stock prices rebound relatively quickly.
On the other hand, if you’re in your 50s or early 60s then you may already have begun the move to bonds in your 401(k). That might be natural as you lean more toward income-producing investments, such as bonds, versus growth-focused ones.
It’s also important to look at the bigger financial picture in terms of where else you have money invested. Diversification matters for managing risk in your portfolio and before switching to bonds in your 401(k), it’s helpful to review what you’ve invested in your IRA or a taxable brokerage account. It’s possible that you may already have bond holdings elsewhere that could help to balance out any losses triggered by a bear market.
There are various rules of thumb you can use to determine your ideal asset allocation. The 60/40 rule, for example, dictates having 60% of your portfolio in stocks and 40% dedicated to bonds. Or you may use the rule of 100 or 120 instead, which advocate subtracting your age from 100 or 120. So, if you’re 30 years old and use the rule of 120, you’d keep 90% of your portfolio in stocks and the rest in bonds or other safer investments.
Consider Bond Funds
Bond mutual funds and bond ETFs could be a more attractive option than traditional bond investments if you’re worried about bear market impacts on your portfolio. With bond ETFs, for example, you can own a collection of bonds in a single basket that trades on an exchange just like a stock. This could allow you to buy in low during periods of volatility and benefit from price appreciation as you ride the market back up. Sinking money into individual bonds during a bear market or recession, on the other hand, can lock you in when it comes to bond prices and yields.
If you’re weighing individual bonds, remember that they aren’t all alike and the way one bond reacts to a bear market may be different than another. Treasury-Inflation Protected Securities or TIPS, for example, might sound good in a bear market since they offer some protection against inflationary impacts but they may not perform as well as U.S. Treasurys. And shorter-term bonds may fare better than long-term bonds.
How to Manage Your 401(k) in a Bear Market
When a bear market sets in, the worst thing you can do is hit the panic button on your 401(k). While it may be disheartening to see your account value decreasing as stock prices drop, that’s not necessarily a reason to overhaul your asset allocation.
Instead, look at which investments are continuing to perform well, if any. And consider how much of a decline you’re seeing in your investments overall. Look closely at how much of your 401(k) you have invested in your own company’s stock, as this could be a potential trouble spot if your company takes a financial hit as the result of a downturn.
Continue making contributions to your 401(k), at least at the minimum level to receive your employer’s full company match. If you can afford to do so, you may also consider increasing your contribution rate. This could allow you to max out your annual contribution limit while purchasing new investments at a discount when the market is down. Rebalance your investments in your 401(k) as needed to stay aligned with your financial goals, risk tolerance and timeline for retiring.
The Bottom Line
Moving 401(k) assets into bonds could make sense if you’re closer to retirement age or you’re generally a more conservative investor overall. But doing so could potentially cost you growth in your portfolio over time. Talking to your 401(k) plan administrator or your financial advisor can help you decide the best way to weather a bear market or economic slowdown while preserving retirement assets.
Tips for Investing
- It’s helpful to review your 401(k) at least once per year to see how your investments are performing and whether you’re still on track to reach your retirement goals. If you notice that you’re getting overweighted in a particular asset class or stock market sector, for example, you may need to rebalance to get back on track. You should also review the fees you’re paying for your 401(k), including individual expense ratios for each mutual fund or ETF you own.
- Consider talking to a professional financial advisor about the best strategies to implement when investing in bear markets and bull markets as well. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool makes it easy to connect with professional advisors online. It takes just a few minutes to get your personalized advisor recommendations. If you’re ready, get started now.
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About Our Investing Expert
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As a new investor, one piece of advice you hear time and time again is that you need to have a balanced investment portfolio. The general idea is to maintain an investment portfolio that has a proper balance between risk and reward in order to meet your long-term financial goals.
You’re told that if your investment portfolio isn’t balanced correctly, it will leave you exposed to significant losses. You’re told that a balanced portfolio is key to long-term investing success.
But what exactly is a balanced portfolio and how do you create and manage one?
What Is a Balanced Investment Portfolio?
A balanced investment portfolio is a highly diversified collection of financial products designed to produce long-term gains while protecting you from significant losses that can result from the failure of one or more investment decisions.
The creation of a properly balanced investment portfolio starts with generally accepted levels of diversification and is adjusted to the unique risk tolerance and financial goals of the investor behind the portfolio.
Because a balanced portfolio consists of a heavily diversified collection of assets, if one or two of these assets experience significant losses, gains in the other assets across the portfolio will soften the blow or even outpace the losses to yield an overall gain. This lets you feel a degree of confidence in your investment portfolio without worrying about whether each individual asset is up or down.
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Steps to Creating a Balanced Portfolio
Although at first glance creating and managing a balanced investment portfolio may seem like a convoluted process, it’s actually quite simple. In fact, by following the four simple steps below, you’ll be well on your way to stock market success.
Step 1: Always Consider Diversification
The most important aspect of a balanced investment portfolio is diversification. Diversification is the process of investing small amounts of money across a wide range of assets and asset classes. This ensures that you don’t fall victim to the volatility of an individual stock or other single asset within your portfolio.
Once you get the general idea of diversification down, the rest is all about adjusting your portfolio to your unique preferences.
The 5% Rule
A general rule of thumb in terms of creating a well-diversified portfolio is known as the 5% rule. This rule suggests that no more than 5% of your total investing capital should be invested into any single asset. Moreover, it suggests that no more than 5% of your investing funds should be invested across any group of high-risk investments.
For example, if you have $10,000 to invest, the 5% rule stipulates the following limits:
- General Investments. Based on a $10,000 investment portfolio balance, you should invest no more than $500 in any single stock, bond, mutual fund, exchange-traded fund (ETF), index fund, or any other investment vehicle in a balanced portfolio, regardless of how low the perceived risk associated with the investment is.
- High-Risk Investments. High-risk investments can be hard to ignore, as high risk usually comes with the potential for compelling gains. However, you should never expose more than 5% of your investing dollars to high-risk investments like penny stocks and over-the-counter (OTC) stocks. So, you should have no more than $500 invested across all of your high-risk positions based on a $10,000 portfolio balance. That leaves 95% of your investment funds, or $9,500, to be invested in low- and moderate-risk general investments like bonds, investment grade funds, and large-cap and blue-chip stocks.
Keep in mind that the 5% rule provides maximum investment guidelines, not minimums. You don’t have to invest 5% of your portfolio into high-risk assets, nor do you have to invest 5% of your portfolio in every stock, ETF, or mutual fund you buy. As long as you don’t invest any more than 5% in a single asset or across all high-risk assets, you’ll create a well diversified investment portfolio.
Consider Investment Grade Funds
To add to the level of diversification within your portfolio, consider investment grade funds. These include index funds, ETFs, and mutual funds. Because these funds are designed to expose investors to an entire stock market index or sector, or to the entire stock market as a whole, these investments are naturally heavily diversified.
If you decide to go the investment grade fund route, there are a few factors that should be considered before making your investment:
- Expense Ratio. The expense ratio of an investment grade fund reflects the amount of assets in the fund that are used to cover the cost of its annual expenses. The higher the expense ratio, the more costs associated with the fund will cut into your return on investment.
- Average Long-Term Investment Return. When choosing an ETF, index fund, or mutual fund, it’s worth looking into the returns the fund has experienced over the past year as well as annualized returns over the past three, five, and 10 years. This will give you a view of how the fund has done historically. Although past performance is not always indicative of future performance, it’s well worth looking into the past performance to see how well the fund managers have done over time.
- Income. Finally, some funds are geared toward growth, some toward value, and some toward income. Often, income-geared funds will underperform when it comes to price appreciation, but that underperformance is largely made up by the income the investment generates, such as through dividends. So, if you’re going to look into ETFs, mutual funds, and index funds that revolve around income, make sure that you look into the total returns generated through the fund rather than simply considering price appreciation.
Diversification Across Asset Classes
When investing, you have the option to invest across a wide range of different asset classes. You’re not simply tied to stocks, bonds, and funds. It’s also a good idea to think outside of the box and consider real estate investments, precious metals, foreign currency, and other nontraditional types of investments.
When diversifying heavily across different asset classes, you’re protecting yourself from significant losses should assets across an entire class lose significant value.
Believe it or not, it happens all the time. For example:
- Precious Metals. Precious metals are known to experience growth during tough economic times and declines when economic times are positive. This is due to their standing as a safe-haven investment.
- Bonds and Other Fixed-Income Investments. Bonds and other fixed-income investments like bond funds provide coupon rates, which are equivalent to interest rates on loans and credit cards. However, this makes the bond market heavily exposed to interest rate risk. As interest rates rise, the value of fixed-income investments fall, while reductions in overall interest rates are a positive for the bond market.
- Stocks and Investment Grade Funds. Stocks and investment grade funds are often at the mercy of economic development. When economic conditions falter, these investments tend to experience significant losses.
Taking diversification to the next level, it’s also a good idea to look into international stocks for opportunities. In particular, investments in emerging markets offer an exciting opportunity to tap into the growth of global markets seeing incredible expansion.
However, global diversification isn’t just about taking advantage of growth in emerging markets. It also protects your portfolio from significant losses, should the United States economy take a hit while the global economy is performing well.
In these cases, ensuring that you are exposed to growth in international markets will soften the blow of declines experienced here at home.
Step 2: Take Advantage of Time Horizon-Based Asset Allocation
You’ve likely heard that “time is money” since you were a child. You’ve learned that every second of the day is valuable, and wasting time is just like wasting money.
This statement is no more true anywhere else in the world than in the stock market.
It’s important to know your time horizon — that is, how long you have before you plan to need access to your investment capital. Adjusting your investment portfolio’s asset allocation to be in line with your time horizon is just as important as choosing the right assets to invest in.
The general idea is that younger investors have more time to recover, allowing them the ability to recoup any losses should something go wrong. As such, with a longer time horizon, younger investors generally can take more risks.
As a rule of thumb, to adjust your portfolio based on your time horizon, all you need to do is consider your age. Many recommend balancing your portfolio so that your low-risk assets represent a percentage equal to your age. So, if you are 35 years old, 35% of your investment portfolio should be invested in low-risk asset classes like bonds and bond funds, while 65% of your investment portfolio should be allocated to higher risk assets like shares of stock. Once you reach age 50, you’d want half of your portfolio to be allocated to low-risk assets with half allocated to higher-risk assets.
Following this strategy, as you age your portfolio moves to a low-risk allocation, with most of your assets in the market being held in bonds and other low-risk investment vehicles by the time you hope to retire and live off your nest egg. This approach helps you to avoid sequence of returns risk, wherein an ill-timed market downturn wreaks havoc on your portfolio when you are least able to recover.
Pro tip: As you’re adding stocks to your portfolio, make sure you’re choosing the best possible companies. Stock screeners like Trade Ideas can help you narrow down the choices to companies that meet your individual requirements. Learn more about our favorite stock screeners.
Step 3: Adjust for Your Personal Risk Tolerance
Everything described above is based on the general amount of risk that the average investor is willing to accept, but everyone is unique. What if your risk tolerance is higher or lower than average? How would you handle asset allocation and diversification in that scenario?
Asset Allocation for Lower Risk
If you’d rather take a low-risk approach to investing, adjust your portfolio based on the following rules:
- The 2.5% Rule. If losing 5% of your portfolio’s value on a bum investment scares you, you may want to consider heavier diversification. Instead of following the 5% rule, make yourself a 2.5% rule. In this case, only 2.5% of your total investment portfolio’s value would be invested across all high-risk assets, with the maximum amount invested in any single asset being 2.5% regardless of risk.
- Asset Allocation. Another tactic to reduce your risk is to invest more money in bonds. Instead of using your age as the percentage of your portfolio you will allocate to bonds, use your age plus 10. For example, in a low-risk portfolio, at 35 years old, you might target having 45% of your investment dollars in a low-risk asset allocation. This allocation may be too conservative for some investors who prefer to be more invested in higher-risk assets with higher returns, but this approach may appeal to the more risk-averse.
Asset Allocation for Higher Risk and Potentially Higher Reward
If you’re more into living on the edge and are willing to accept a higher level of risk for the potential of a higher payout, you’ll want to follow these rules:
- The 7.5% Rule. Even in a high-risk investment portfolio, you shouldn’t have any more than 7.5% of your investing dollars tied up in a single investment regardless of risk, or across a group of high-risk investments. But you can adjust the 5% rule to a 7.5% rule if you want to walk on the wild side.
- Asset Allocation. In a high-risk investment portfolio, you’ll want to invest even more in stocks and other investments with high potential returns than you would in a medium-risk allocation, and less in conservative investments such as bonds. For a higher-returning asset mix, you might subtract 10 from your age to calculate your low-risk asset allocation. For example, if you’re 35-years-old, you would only allocate 25% of your investment dollars toward bonds, bond funds, and other low-risk assets. This allocation still becomes lower-risk as you age but leaves you invested in high-risk, high-returning assets longer, for a theoretically higher return in the long run.
Step 4: Rebalance Your Investment Portfolio Regularly
Creating a balanced investing portfolio is only the first step of responsible investing. At the end of the day, investing is not a set-it-and-forget-it endeavor. Even buy-and-hold investors are consistently rebalancing their investment accounts to ensure that their portfolios stay in line with their financial goals.
In the stock market, short-term downturns are a common occurrence, but it’s important to keep a close eye on your investments to make sure that any downtrends are indeed short term.
Moreover, as assets in your portfolio grow in value, you’ll notice that the rate of growth will be different across your individual investments. Assets that grow the most will come to represent a larger percentage of your portfolio, while slower-growing assets will lag behind and become a shrinking piece of the pie. This varying rate of growth will result in an unbalanced investment portfolio if not kept in check.
As a result, successful investors tend to go through the process of rebalancing their investment portfolios at least on a quarterly basis. Some of the most successful investors rebalance monthly.
There are three steps to rebalancing an investment portfolio:
1. Review Asset Allocation Following Recent Price Movements
With asset values growing and falling at different rates across your portfolio, your preferred allocation on individual investments will fall out of balance. So start by making sure of two things:
- Asset Allocation. First make sure that your asset allocation is still in line with your investment strategy. If stocks have risen to become too much of your allocation, cash in on some of your stocks and buy bonds to bring the balance back. If stocks are down or bonds have risen faster than stocks, you’ll want to cash in on bonds and add exposure to stocks to take advantage of the next market upswing.
- Maximum Investment Caps. Some stocks may grow to become worth more than your limit of 5% of your general-risk investment portfolio (or 2.5% in a low-risk portfolio or 7.5% in a high-risk portfolio). Should this take place, sell enough shares of that asset to keep it in line with your investment strategy.
2. Gauge the Performance of Individual Investments
Once your portfolio is back in line with your investing strategy, take a look at each of your individual investments. In particular, pay close attention to the performance of the investments since your most recent rebalancing of your investment portfolio.
As you do so, you’ll find that some investments are outperforming others, and in some cases investments are duds, with either flat movement or long-term losses.
In this step, you might want to cut your losses, selling your positions in the duds and freeing up those funds for investments that will provide you with better returns.
3. Look for New Opportunities to Fill in the Blanks
At the ends of your rebalancing process, you might find that you have uninvested cash in your portfolio. Due to inflation, unused cash is an asset that only loses value. So, instead of leaving cash lying around, look for new opportunities in the market to invest in.
A balanced investment portfolio is the key to compelling long-term investment returns while keeping risk at a minimum. Although some question the validity of diversification, the vast majority of experts suggest that investors maintain a healthy amount of diversification in their portfolios.
By following the steps above, you’ll have the ability to not only create a balanced portfolio, but you’ll have the tools you need to maintain and rebalance your portfolio regularly.
Monthly rebalancing may be cumbersome, but is well worth the time. Not only does this keep your investment portfolio more in line with your financial goals, it keeps you in the know with your investments, giving you the ability to act if significant losses are likely on the horizon.
The Kiplinger 25 list of our favorite no-load mutual funds dates back to 2004, and our coverage of mutual funds goes all the way back to the 1950s. We believe in holding funds rather than trading them, so we focus on promising mutual funds with solid long-term records – and managers with tenures to match.
Over the past 12 months, U.S. stocks hit new highs, and then a viral pandemic snuffed out a nearly 11-year bull market, wiping out gains in just days … and then stocks bounced back into a new bull market just a few months later. The major indices have been roaring ever since, and have been regularly setting all-time highs of late.
That has many (but not all) of our Kiplinger 25 picks looking like their old selves.
Over the past decade, for instance, the 11 U.S. diversified stock funds with 10-year records returned an average of 13.4% annualized, right on par with the S&P 500 Index. Our seven bond funds as a group beat the Bloomberg Barclays U.S. Aggregate Bond Index over the past five and 10 years on an annualized-return basis.
Here are our picks for the best 25 low-fee mutual funds: what makes them tick, and what kind of returns they’ve delivered.
Data is as of Jan. 28, unless otherwise noted. Three-, five- and 10-year returns are annualized. Yields on equity funds represent the trailing 12-month yield. Yields on balanced and bond funds are SEC yields, which reflect the interest earned after deducting fund expenses for the most recent 30-day period.
– Fund not in existence for the entire period.
Dodge & Cox Stock
- Symbol: DODGX
- 1-year return: 10.1%
- 3-year return: 4.9%
- 5-year return: 14.7%
- 10-year return: 11.5%
- Yield: 1.7%
- Expense ratio: 0.52%
The focus: Cheap shares in large firms.
The process: Ten managers home in on well-established companies with attractive prices and long-term prospects. Portfolio managers are patient and invest with a three- to five-year horizon in mind.
The track record: The fund is prone to streaky returns because the managers’ out-of-favor bets can take time to play out. Be patient. Over the past 10 years, the fund’s 11.5% annualized return beats 95% of its peers, which are funds that invest in bargain-priced large-company stocks. But, like many value-oriented funds, it lags Standard & Poor’s 500-stock index, which boasts a 13.5% annual total return (price plus dividends).
The upshot: Markets are cyclical, and this investing style will come back.
Mairs & Power Growth
- Symbol: MPGFX
- 1-year return: 17.4%
- 3-year return: 11.0%
- 5-year return: 15.6%
- 10-year return: 12.9%
- Yield: 1.0%
- Expense ratio: 0.65%
The focus: Upper Midwest firms of all sizes with durable competitive advantages, trading at bargain prices.
The process: Three managers spend months analyzing a company’s niche in its market and its management team before they buy. The fund tilts toward health care and industrial firms. While MPGFX does hold some tech and communications giants, such as Microsoft (MSFT), Google parent Alphabet (GOOGL) and chipmaker Nvidia (NVDA), the fund’s top 10 holdings aren’t as heavy on tech names as many large-cap U.S. stock funds.
The track record: The fund “struggles in strong markets and picks up ground in downturns,” says lead manager Andy Adams. Growth’s 15-year annualized return beats 70% of similar funds. But over the past 12 months, it beats about half.
The upshot: The pandemic may have roiled stocks last year, but the managers will “stick to their knitting,” says Adams.
Primecap Odyssey Growth
- Symbol: POGRX
- 1-year return: 25.6%
- 3-year return: 10.6%
- 5-year return: 19.4%
- 10-year return: 15.0%
- Yield: 0.4%
- Expense ratio: 0.65%
The focus: Long-term bets on attractively priced, fast-growing firms.
The process: Five managers run a portion of assets independently. They all look for companies with better growth prospects than their share prices imply. And they buy for the long term: The typical holding period is 10 years.
The track record: This aggressive growth fund’s one-year return ranks behind 94% of its peers, in part because of big drops in Alkermes (ALKS) and Southwest Airlines (LUV). Smart investors will hold on. The fund’s 15-year record beats the S&P 500 by an average of 1.6 percentage points per year.
The upshot: These proven managers know how to block out the noise. We’re hanging in.
T. Rowe Price Blue Chip Growth
- Symbol: TRBCX
- 1-year return: 30.5%
- 3-year return: 17.1%
- 5-year return: 22.5%
- 10-year return: 17.6%
- Yield: 0.0%
- Expense ratio: 0.69%
The focus: Established companies with strong growth prospects.
The process: Manager Larry Puglia favors firms with sustainable competitive advantages over rivals, strong cash flow, healthy balance sheets and executives who spend in smart ways. The company’s top holding is Amazon.com (AMZN, 11.3% of assets), which has been one of the darlings of the COVID-period market, up 76% in 2020 versus 18% for the S&P 500. In April, Puglia took on an associate manager, Paul Greene, but says he has no plans to retire.
The track record: Puglia beats the S&P 500 index handily over the past three, five and 10 years – and, despite the recent market volatility, over the past 12 months as well.
The upshot: Blue Chip Growth was a prime beneficiary of the long bull market, but the fund has held up well since the market crashed. And over the long stretch of a full market cycle, Puglia has outpaced the S&P 500.
T. Rowe Price Dividend Growth
- Symbol: PRDGX
- 1-year return: 11.3%
- 3-year return: 11.3%
- 5-year return: 15.8%
- 10-year return: 13.1%
- Yield: 1.0%
- Expense ratio: 0.63%
The focus: Firms with a mindset to increase dividend payouts over time.
The process: Manager Tom Huber focuses on large, high-quality companies that generate strong free cash flow (cash profits after capital expenditures) and have the capacity and willingness to raise their payouts.
The track record: PRDGX lags the S&P 500 by more than 6 percentage points over the past year. But its 15-year annualized return slightly edges out the S&P 500 and beats 86% of its peers (funds that invest in stocks with value and growth traits).
The upshot: T. Rowe Price Dividend Growth, an all-weather portfolio, keeps pace in good markets and holds up well in down markets.
- Symbol: VEIPX
- 1-year return: 3.5%
- 3-year return: 4.5%
- 5-year return: 11.9%
- 10-year return: 11.3%
- Yield: 2.6%
- Expense ratio: 0.27%
The focus: Dividend-paying stocks.
The process: Wellington Management’s Michael Reckmeyer runs two-thirds of the assets; Vanguard’s in-house quantitative stock-picking group manages the rest. Together, they build a portfolio of about 180 large companies, including Johnson & Johnson (JNJ), Procter & Gamble (PG) and JPMorgan Chase (JPM).
The track record: Health care stocks were a boon to the fund in 2019, but it has struggled over the past year, with a mere 3.5% gain. Nonetheless, over the past decade, VEIPX has beaten 93% of its peers (funds focused on large, value-priced firms).
The upshot: The fund offers above-average returns for below-average risk.
DF Dent Midcap Growth
- Symbol: DFDMX
- 1-year return: 21.4%
- 3-year return: 18.0%
- 5-year return: 21.6%
- 10-year return: –
- Yield: 0.0%
- Expense ratio: 0.98%
The focus: Growing midsize companies.
The process: Four managers find solid businesses that dominate their industries, generate plenty of cash and are run by executives who spend wisely. The fund will hold on to shares as long as a firm is still growing fast. Shares in large-cap stock Ecolab (ECL) have been in the fund since 2011.
The track record: DFDMX has beaten the majority of its peers in seven of the past nine calendar years.
The upshot: Mid-cap stocks are often in the market’s sweet spot. Typically, these firms are growing faster than large companies and are less volatile than small businesses.
Parnassus Mid Cap
- Symbol: PARMX
- 1-year return: 12.4%
- 3-year return: 9.6%
- 5-year return: 14.6%
- 10-year return: 11.9%
- Yield: 0.2%
- Expense ratio: 0.99%
The focus: Growing midsize firms that pass environmental, social and governance (ESG) measures.
The process: Two longtime managers, 18 analysts and a dedicated ESG team pick 40 stocks, with sustainability in mind. Hologic (HOLX), a diagnostics and medical imaging company, and Republic Services (RSG), a waste-collection service, are among the top holdings.
The track record: PARMX’s one-year return has beaten 68% of its peers. Over 10 years, the fund’s 12.0% annualized return beat 87% of its peers.
The upshot: At the moment, technology is the largest sector allocation at more than a quarter of assets. The fund is also heavily invested in industrials (21%) and healthcare (14%).
T. Rowe Price Small-Cap Value
- Symbol: PRSVX
- 1-year return: 15.5%
- 3-year return: 7.5%
- 5-year return: 15.3%
- 10-year return: 10.8%
- Yield: 0.4%
- Expense ratio: 0.83%
The focus: Unloved, under-the-radar, bargain-priced small companies.
The process: Financially sound firms with a competitive edge over rivals and a strong management team make it into the fund. PennyMac Financial Services (PFSI), a national mortgage lender, and Belden (BDC), a maker of networking and cable products, are among PRSVX’s top holdings.
The track record: Small-cap value stocks have been the worst-performing U.S. category in recent years. But this fund is only a little behind the Russell 2000 index over the trailing five-year period.
The upshot: Small-cap stocks have gained some wind in their sails of late, but they still have some catching up to do compared to their large-cap brethren. PRSVX provides exposure to the some of the best values among smaller companies.
T. Rowe Price QM U.S. Small-Cap Growth
- Symbol: PRDSX
- 1-year return: 24.0%
- 3-year return: 13.2%
- 5-year return: 19.0%
- 10-year return: 14.5%
- Yield: 0.0%
- Expense ratio: 0.79%
The focus: Small, growing companies.
The process: Using quantitative models (hence the “QM” in its name) developed initially while he was in academia, Sudhir Nanda and his team focus their sights on high-quality, highly profitable firms with reasonably priced shares. Samuel Adams beer crafter Boston Beer (SAM) and semiconductor-materials provider Entegris (ENTG) are among top holdings.
The track record: The fund has handily beaten the Russell 2000 small-cap stock index over the past three, five and 10 years.
The upshot: Since the end of 2019, shares in small companies are up less than 7%. But Nanda focuses more on an individual company’s business characteristics than on big-picture market or economic issues.
Wasatch Small Cap Value
- Symbol: WMCVX
- 1-year return: 20.1%
- 3-year return: 8.4%
- 5-year return: 16.7%
- 10-year return: 12.1%
- Yield: 0.0%
- Expense ratio: 1.20%
The focus: Temporarily underpriced shares in small, fast-growing firms.
The process: This is a growth-ier value fund. The portfolio’s 60-odd stocks fall into one of three buckets: undiscovered, little-known companies; firms suffering a temporary setback; and cheap stocks in steadier, slow-growth businesses.
The track record: The fund is back in a groove, with a 20% gain over the past 12 months. Its three-, five- and 10-year records rank among the top 68%, 77% and 85% of similar funds, respectively.
The upshot: Despite their recent poor performance, small-cap stocks offer higher growth potential than their large-company brethren. To cash in, you must have a long-term view and be willing to bear some turbulence.
Fidelity International Growth
- Symbol: FIGFX
- 1-year return: 16.2%
- 3-year return: 9.0%
- 5-year return: 13.5%
- 10-year return: 9.1%
- Yield: 0.1%
- Expense ratio: 1.01%
The focus: Growing foreign companies.
The process: Manager Jed Weiss homes in on firms with good growth prospects and strong niches in their businesses that give them pricing power – the ability to hold prices firm in bad times and raise them in good times.
The track record: Weiss outpaced the MSCI EAFE index in 10 of the past 12 calendar years. His fund’s average 10-year return beats 78% of all foreign large-company stock funds. FIGFX tends to hold up well in bad markets.
The upshot: Weiss picks stocks one at a time, but he says long-term growth theme are set to propel returns going forward. At the moment, top holdings include the likes of Japanese sensor firm Keyence and multinational chemicals firm Linde (LIN).
Janus Henderson Global Equity Income
- Symbol: HFQTX
- 1-year return: 3.7%
- 3-year return: 0.3%
- 5-year return: –
- 10-year return: –
- Yield: 7.5%
- Expense ratio: 0.97%
The focus: High income in international-company equities.
The process: The fund aims “to provide a consistently high level of income while investing in overseas markets with a value bias,” says Ben Lofthouse, one of the fund’s three comanagers. “We look for the dividend to be sustainable.” To that end, firms with strong balance sheets, steady profits and cash flow are ideal for the fund. “Profitable companies have downside protection when things don’t go as well,” says Lofthouse.
The track record: Relative to other large-company foreign value stock funds, Global Equity Income shines. Over the past three years, the fund ranks among the top 33% of its peers. It currently yields 7.9%, and the fund says the annualized distribution yield “has consistently been around 6%.”
The upshot: In recent years, the managers have put aside some value measures, such as share price in relation to book value (assets minus liabilities), in favor of other gauges, such as the price-to-cash-flow ratio, that they say are better predictors of future returns. That should help them better identify values going forward.
Baron Emerging Markets
- Symbol: BEXFX
- 1-year return: 33.7%
- 3-year return: 6.2%
- 5-year return: 15.6%
- 10-year return: 7.3%
- Yield: 0.0%
- Expense ratio: 1.35%
The focus: Emerging-markets firms of all sizes.
The process: Manager Michael Kass favors profitable, growing firms with steady competitive advantages. Asian tech giants Samsung, Tencent Holdings (TCEHY) and Taiwan Semiconductor (TSM) top the portfolio.
The track record: After a decade of sluggish returns, peppered with a few good years (such as 2019), emerging-markets stocks got socked again, this time by the coronavirus. But they have roared back. Over the past year, the fund has beaten the MSCI Emerging Markets index by more than 6 percentage points.
The upshot: There’s still uncertainty about the impact of the coronavirus on emerging-markets economies, but BEXFX should continue benefiting as EMs recover.
AMG TimesSquare International Small Cap Fund
- Symbol: TCMPX
- 1-year return: 15.3%
- 3-year return: 0.6%
- 5-year return: 10.7%
- 10-year return: –
- Yield: 1.4%
- Expense ratio: 1.23%
The focus: Small firms in developed foreign countries.
The process: Four managers circle the globe to find best-in-class companies. Japan, the U.K. and Italy are the fund’s biggest country exposures.
The track record: Small-cap foreign stocks have not fared well compared with shares in larger companies in recent years, but TCMPX has beaten its benchmark, the MSCI EAFE Small Cap Index, since inception in 2013.
The upshot: Volatility doesn’t faze these managers. “We can’t guess what the market will do tomorrow, but we can invest in outstanding companies we think can continue to grow,” says lead manager Magnus Larsson.
Fidelity Select Health Care
- Symbol: FSPHX
- 1-year return: 25.9%
- 3-year return: 17.5%
- 5-year return: 18.1%
- 10-year return: 18.9%
- Yield: 0.5%
- Expense ratio: 0.70%
The focus: Healthcare stocks.
The process: Eddie Yoon, manager since 2008, divides the portfolio into three parts: steady, growing firms, which make up the biggest chunk of the fund; fast-growing, proven companies with focused niches; and emerging biotech businesses.
The track record: Yoon’s 10-year annualized record beats 80% of all healthcare-focused funds.
The upshot: Yoon is getting defensive, piling into stable growers, while keeping an eye on innovative firms in areas such as gene and cell therapy.
- Symbol: VWELX
- 1-year return: 9.1%
- 3-year return: 7.6%
- 5-year return: 11.7%
- 10-year return: 9.5%
- Yield: 1.5%
- Expense ratio: 0.25%
The focus: A balanced portfolio of roughly 65% stocks and 35% bonds at the moment. Buy shares through Vanguard if you’re new to the fund; otherwise, it’s closed.
The process: Managers focus on large-company, dividend-paying stocks, high-quality government bonds and investment-grade corporate debt. The fund yields 1.5%.
The track record: Despite the coronavirus, the fund has beaten 82% of its peers over the past five years.
The upshot: The managers like a bargain. Before the pandemic, they were waiting for discounts in large banks and consumer names. Defensive moves on the bond side, such as focusing on the highest-quality corporate debt and setting aside cash for a correction, were well timed.
DoubleLine Total Return Bond
- Symbol: DLTNX
- 1-year return: 2.9%
- 3-year return: 4.0%
- 5-year return: 3.1%
- 10-year return: 4.1%
- Yield: 2.8%
- Expense ratio: 0.73%
The focus: Mortgage-backed securities.
The process: Three managers balance government-guaranteed mortgage-backed bonds – which are sensitive to interest-rate moves (when interest rates rise, bond prices fall, and vice versa) but have no default risk – with non-agency mortgage bonds, which have some risk of default, but little interest-rate sensitivity.
The track record: The fund holds no corporate debt, which has hurt relative returns in recent years. Over the past five years, the fund’s 3.1% annualized return lags the Bloomberg Barclays U.S. Aggregate Bond index.
The upshot: Mortgage rates continue to sit near all-time lows. And the primary risk for most mortgage-backed bonds is the potential that mortgage holders will prepay their principal. We’re watching DLTNX closely. Meanwhile, it yields 2.8%.
Fidelity Intermediate Municipal Income
- Symbol: FLTMX
- 1-year return: 3.7%
- 3-year return: 4.4%
- 5-year return: 3.3%
- 10-year return: 3.8%
- Yield: 0.8%
- Expense ratio: 0.35%
The focus: Debt that is exempt from federal income taxes, issued by states and counties to fund expenses such as schools and transportation.
The process: Four managers choose high-quality, attractively priced muni bonds. Managing risk is a priority, too.
The track record: This fund consistently posts above-average returns in its category. It rarely tops the charts, but it tends to hold up better in downturns.
The upshot: Muni bonds were richly priced until COVID-19 events fueled a selloff. But low rates and steady demand has propped prices back up. The fund yields 0.8%, or 1.4% for investors in the highest tax bracket.
Fidelity New Markets Income
- Symbol: FNMIX
- 1-year return: 2.5%
- 3-year return: 1.5%
- 5-year return: 6.3%
- 10-year return: 5.5%
- Yield: 4.1%
- Expense ratio: 0.82%
The focus: Emerging-markets debt.
The process: Longtime manager John Carlson has retired, but his replacements, Jonathan Kelly and Timothy Gill, are longtime analysts for the fund. Not much will change. The fund will still focus on dollar-denominated government bonds, but Kelly says he will likely hold a more consistent position in corporate debt, now 15% of assets. Mexico, Turkey and Ukraine are its top country exposures.
The track record: Carlson’s 15-year return was in the top 23% of emerging-markets debt funds. We’re watching closely to see how Kelly and Gill do.
The upshot: Yields on emerging-markets debt are still near historic lows. But the exit path from the coronavirus is still uncertain, so while a recovery is expected at some point, a shadow remains over near-term economic growth projections in emerging countries. Even so, the fund’s yield, 4.1%, is attractive.
Metropolitan West Total Return
- Symbol: MWTRX
- 1-year return: 6.8%
- 3-year return: 6.0%
- 5-year return: 4.3%
- 10-year return: 4.4%
- Yield: 0.9%
- Expense ratio: 0.68%
The focus: High-quality intermediate-maturity bonds.
The process: Four bargain-minded managers make the big-picture calls on the economy and invest accordingly in investment-grade bonds (those rated triple-B or better).
The track record: The fund got defensive early, nipping returns in 2016 and 2017. But its conservative position – it’s currently loaded up on Treasuries, government mortgage-backed bonds and investment-grade corporates – has been a boon over the past year, especially since the start of 2020. Total Return’s one-year return beats 63% of its peers, and its 10-year annualized return beats 65% of its peers. Both returns beat the Bloomberg Barclays U.S. Aggregate Bond index.
The upshot: The managers are “patient and disciplined,” says Morningstar analyst Brian Moriarty, and that should continue to set this fund’s performance apart over the long term.
Fidelity Advisor Strategic Income
- Symbol: FADMX
- 1-year return: 6.9%
- 3-year return: 5.1%
- 5-year return: 6.3%
- 10-year return: 4.8%
- Yield: 2.4%
- Expense ratio: 0.68%
The focus: The fund seeks to deliver more yield than the Bloomberg Barclays Aggregate U.S. Bond index by investing in a blend of government debt and junkier, higher-yielding bonds. The fund yields 2.4%.
The process: Comanagers Ford O’Neil and Adam Kramer make broad calls on which bond sectors to emphasize while specialists do the individual bond picking.
The track record: The fund has returned 6.3% annualized over the past five years, which has handily beaten the Agg index.
The upshot: These days, the fund holds mostly high-yield debt (roughly 46% of assets), government securities (20%) and emerging-markets bonds (15%).
Vanguard High-Yield Corporate
- Symbol: VWEHX
- 1-year return: 5.0%
- 3-year return: 5.6%
- 5-year return: 7.4%
- 10-year return: 6.2%
- Yield: 3.0%
- Expense ratio: 0.23%
The focus: Corporate debt rated below investment grade.
The process: Manager Michael Hong keeps risk at bay by focusing on debt rated double-B, the highest quality of junk bonds.
The track record: The fund struggles to top the charts in go-go years, but it leads in so-so years. All told, its 10-year annualized return beats 86% of its peers. It yields 3.0%.
The upshot: High-yield rates, on average, were near historic lows until the pandemic bumped them above 6% in early March, though they’ve since come back down to record lows from there. (When rates rise, bond prices fall, and vice versa.) We’re watching VWEHX carefully.
Vanguard Short-Term Investment Grade
- Symbol: VFSTX
- 1-year return: 4.5%
- 3-year return: 4.0%
- 5-year return: 3.2%
- 10-year return: 2.6%
- Yield: 0.7%
- Expense ratio: 0.20%
The focus: To deliver a higher yield than cash and short-term government bonds. VFSTX currently yields 0.7%.
The process: Three managers, who took over in April 2018, invest in high-quality corporate debt, pooled consumer loans and Treasuries, with maturities that range between one and five years.
The track record: The fund has returned 3.5% annualized over the past three years, which outpaces 87% of its peers.
The upshot: Low rates mean low yields for now. But pressing uncertainties, such as the unknown recovery time from coronavirus, negative rates in other parts of the world and geopolitical risks, make this fund a welcome haven.
TIAA-CREF Core Impact Bond
- Symbol: TSBRX
- 1-year return: 5.1%
- 3-year return: 5.3%
- 5-year return: 4.2%
- 10-year return: —
- Yield: 1.0%
- Expense ratio: 0.64%
The focus: Bonds issued by companies that meet high ESG standards, as well as projects that deliver a measurable environmental or social impact.
The process: Veteran bond picker and lead manager Stephen Liberatore invests just under two-thirds of the fund in attractively priced, high-quality debt issued by firms that pass his own carefully honed ESG measures. He devotes about 40% of the fund’s assets to fund projects related to alternative energy, affordable housing or community development. The fund was formerly called Social Choice Bond.
The track record: The fund’s 4.2% annualized return over the past five years is just slightly below similar bond funds and the Agg index.
The upshot: Investors don’t sacrifice much performance or yield with these ESG- and impact-focused bonds.
Originally published by David McMillin on Bankrate.com.
If you’re looking for a safe place to store your money while earning a return, you might be thinking about opening a certificate of deposit.
A CD is similar to a traditional savings account, but your bank will pay you a higher interest rate in exchange for locking your funds away for a set amount of time.
The catch for that extra earning potential? Most CDs will charge you a penalty if you need your money before the end of your term.
Right now, though, that extra earning potential isn’t all that much to celebrate. The best rates on 3-year CDs are under 1.25 percent, which means your money will be tied up for a long time with limited benefits.
“I tend to shy away from CDs in today’s environment since the interest rates on these are not materially higher than money market and other deposit accounts,” says Andrew Feldman, CFP, president of Illinois-based AJ Feldman Financial. “And most CDs lock up your funds and are not liquid.”
Depending on your financial goals and your risk tolerance, CDs might still make sense. However, there are other options to minimize your risk and maximize your earnings.
1. Dividend-paying stocks
Some companies pay out portions of their profits to shareholders on a regular basis. Major names like Starbucks and Walmart pay dividends that beat average CD rates. Some companies have a long history of raising dividends, too. For example, Verizon has increased its dividend for 14 years in a row.
Investing in dividend-paying stocks carries the potential to earn a yield higher than CDs, but there’s a real risk you could lose your principal, too. Buy a stock at $20 per share today, and it could be worth $15 per share six months from now.
Kimberly Foss, president of Empyrion Wealth Management in Roseville, California, says because stocks can come with such risk, you have to ask yourself how much risk you’re willing to take.
While that risk can be significant in the short term, it becomes lower in the long term. That’s why you should plan to hold on to any stocks for a period of at least three to eight years.
Many financial advisers recommend against picking individual stocks. Mari Adam, president of Florida-based Adam Financial Associates Inc., says if you take this option, it’s best to spread your risk among a couple of stocks and other investing vehicles.
“You don’t want to put all of your short- or mid-term cash in just one stock or one alternative,” Adam says.
After a 2020 filled with uncertainties amid the pandemic, investors should remember the need to stay the course. You’re investing for the future, not just following the constant swings of the market.
“You really have to keep focused on what your goal is and don’t get distracted by what the market’s doing today or what’s on your statement today because if you do that, you get off that path and you don’t want to do that,” Adam adds.
2. Paying down high-cost debt
Earning a return doesn’t necessarily involve “investing” in the traditional sense. It can also involve getting rid of high-cost debt that might be dragging you down.
If you’re carrying a balance on a credit card with an interest rate of 15 percent from month to month, you’re going to be paying more than the interest you could accrue on a CD or any other traditional saving product.
It’s much better to use your money to get that bill to zero than put it in a low-risk option that might pay 2 percent interest annually.
“Mortgages and a car note might be OK, but you should be paying down anything with a double-digit interest rate,” says Bill Hammer Jr., president of New York-based Hammer Wealth Group.
Paying down credit card debt also protects you against rising interest rates in the future. And once the debt is paid down, it will be easier to put away money on a regular basis and build up your savings.
“Paying down debt is one of the only ways you can get a guaranteed risk-free return,” Hammer says.
3. Peer-to-peer lending
While you want to pay down your debts, others like you might need to borrow some money. Peer-to-peer lending, often known as “P2P lending,” is a creative option if you’re willing to take a little risk for higher reward, Empyrion’s Foss says.
Consider Prosper, which lets you make loans to random strangers and earn a good annual return. Prosper’s data shows that individual investors earn average annual returns of 5.3 percent.
You can lend to borrowers in different risk categories based on their credit scores. Just as a bank can charge a higher interest rate for those with lower credit scores, you get a higher interest rate for agreeing to loan to individuals with less-than-perfect credit.
Foss says it’s a less risky option than the stock market. She recommends sticking with borrowers who have AAA ratings.
“I wouldn’t put all of your cash here, but it might work well as part of a portfolio with dividend-paying stocks and a short-term corporate bond fund,” Foss says.
4. Bond funds
Short-term bond funds are another alternative to investing in CDs. Funds have similar terms such as 1-year and 5-year maturity dates, and they hold bonds in everything from foreign countries to utilities to corporations.
The yields can be quite strong, too. For example, Vanguard’s Short-Term Bond Index Fund, which spreads money across corporate bonds and U.S. government bonds, has earned a 4.78 percent return over the past year.
Another option could be an international bond fund. Many of these funds hold bonds from AAA-rated, creditworthy nations such as France, United Kingdom, Germany and Japan.
There are also emerging market bond funds, although these carry bigger risks.
As you get started, read Bankrate’s guide on how to invest in bonds to educate yourself on the wide range of options.
CD vs. money market vs. Roth IRA
Trying to choose between a CD, a money market account and a Roth IRA? The right answer depends on how you’re planning to use the money you’re stowing away.
If you’re looking for a place to park your emergency funds, for example, you’re probably better off putting it in a money market account, Adam says. That way, you can withdraw it as soon as you need it without concerns of a penalty.
You’ll earn a little bit, too, but nothing to write home about. In the current climate, the best money market rates are sitting around 0.5 percent.
A CD might be a good place for short-term cash you’re planning to use within a year for an expense like buying a car or a house. But it’s not a good place for long-term retirement funds.
Those kinds of savings should go into a retirement account instead, like a Roth IRA that allows withdrawals in retirement to be made tax free since contributions are made with after-tax dollars. And if retirement is still far off in the distance for you, it’s essential to think about the best long-term investments for your strategy.
Are CDs worth it?
Right now, you’ll be hard-pressed to find an interest rate on a standard CD that will justify locking up your funds for an extended period of time. While traditional CDs may not be worth it in the current market, you may want to explore some alternative options for CDs.
For example, Ally Bank offers a CD that gives you the option to request a rate increase that adjusts to the bank’s updated rate (once for the two-year CD and twice for the four-year product).
A number of banks including Marcus by Goldman Sachs offer a CD that allows you to withdraw your funds without paying a penalty.
Be sure to compare Bankrate’s best investments to determine which vehicles are the right avenue for your growth needs.
Are CDs a smart retirement strategy?
“If you [are a] younger person, you’re investing for retirement or something that’s a long-term investment you want, you shouldn’t be in CDs because those are short-term investments in my opinion, with low returns,” Adam adds. “You can’t fund your retirement on a two point whatever return. You’ve got to get more growth.”
To find that growth, Elliot Pepper, CPA, CFP, MST, financial planner and director of tax at Maryland-based Northbrook Financial, recommends target-date funds.
“Many large institutions offer target-date funds, which are very popular in 401(k) or retirement accounts as they essentially offer a set glide path away from riskier investments and into more conservative fixed income investments based on the target date of the fund,” Pepper says.
Once that target date arrives and you actually do retire, CDs might be a good addition to your portfolio. However, it’s important to note that you might luck out and live even longer than you expect. In that case, you could need more than earnings from CDs.
Are CDs tax-free?
A CD will pay you some interest, but you’ll also have to pay taxes on that income. That may take a significant bite out of your earnings, especially if you aren’t saving that much money to begin with.
If you have IRA CDs, you won’t pay taxes on contributions or any interest until you withdraw the money in retirement. If you open Roth IRAs, your distributions in retirement would be free from taxation.
If you’re genuinely concerned about your tax situation, you may want to turn to an alternative — like a municipal bond — to avoid the taxation problem altogether.
Best returns for short-term and long-term funds
A CD is just one option if you’re looking for a place to stash your short-term funds. There is a variety of alternative options, especially if you’re looking for a higher rate of return and are willing to accept the tradeoff with a higher risk.
Besides municipal bonds and short-term bond funds, you could earn a higher yield by investing in a mutual fund. Depending on how you invest your money, you could end up with a yield in the double-digits.
For your long-term funding needs, you’ll need to look beyond CDs.
“CDs aren’t always the right choice, especially if you won’t need the funds for several or more years,” says David Sterman, CFP, president and CEO of New York-based Huguenot Financial Planning. “Funds that focus on longer-term bonds will always offer better yields than CDs.”
Amanda Dixon contributed to some of the original reporting of this updated article.
Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.
Short term investments are those investments that can yield their returns within a short period of time — usually within 1 to 3 years. (contrary to a long term investment such as saving for retirement).
In other words, short term investing are typically used to meet short-term financial goals (such as buying a house or go on a vacation).
A bank checking account is one of the best known and popular ways to save for such a goal.
But your traditional checking account only pays a meager return, if at all.
If you can’t find an alternative to a checking account, no need to fret.
There are plenty of short term investments that will help keep your money safe and earn a good return at the same time.
Below, we’ve curated the best short term investments to help reach your investment goals.
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Things to consider:
First thing first, before you make any short term investments, you should know about the risk, return and investing time frame of short term investments.
- Average return to expect: 1 to 4% per year;
- Risk: very low to low risk of losing money;
- Time frame: 0 to 3 years
Best short term investments:
If you’re saving and investing money for the short term, i.e., to use it as a down payment on a house, you will not invest that money in stocks or mutual funds, right?
That’s because, stocks are high risk investments. And if you need the money for a certain time, it might not be available due stock market volatility.
Instead, a smart choice is to save that money in a low-risk investment where you can protect the capital invested and earn interest/income at the same time.
If you have a different investing goal, such as saving for retirement, it’s best to look at stocks or mutual funds. Investing in stocks or mutual funds is considered a long term investment as opposed to short term investing.
If you’re interested in investing for the long term, here’s how the stock market works.
So, what are your options? Here are some of the best short term investments to consider to earn some interest on your money.
1. Savings account.
A savings account at a bank is an excellent choice. And they usually pay more interest than a regular checking.
They are quite safe. Savings account are insured by the FDIC, but only for up to $250,000.
That means if a bank goes bankrupt, the government will step up and give you your money back.
In addition, they are very liquid. You have access to your money fairly easy.
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2. Certificate of deposit (CDs).
If you want a good rate of return on money that you don’t plan on using within the next couple of years, CDs is a safe place to do invest it.
Banks sell certificate of deposit for a specific dollar amount and length of time. As an investor, you agree to leave a certain amount of money with the bank for a specific time.
When the time is up, the CD matures. Then, you get your money back, plus interest.
CDs are also FDIC insured for up to $250,000. They provide a safe and competitive yield. That makes them some of the best short term investments to consider.
The minimum deposit requires to open a CD depends on the bank. But it usually ranges from a few hundred dollars to thousands.
The CIT Bank is paying 1.30% for an 11-month CD. There is an opening minimum of $1,000. With most CDs, if you tap into your money before maturation, you will get hit with an early withdrawal penalty.
However, with this CIT Bank CD, there is no penalty if you withdraw early.
CIT Bank has various types of CDs. If you prefer longer terms CDs, check them out now at the CIT Bank website.
3. Money market fund
While you can keep your cash at a bank in a savings account because they’re safe there, you don’t have to.
You can try a money market fund. They are safe as well.
A money market fund is a type of mutual fund (but thy don’t focus on stocks or bonds).
Mutual funds companies such as Vanguard offer money market funds.
Money market fund is not insured by the government, so there is a possibility you can lose money. However, they are quite safe.
They’re safe, because they have a dollar invested in securities for every dollar you deposit in your fund.
The principal money you invested does not change in value. When you invest in a money market fund, you earn dividends. That’s a good advantage.
Another advantage of a money market fund as a short term investment is that it provides higher yield than bank savings account.
It also allows you to write checks without incurring any charges.
So, if you’re saving money for a home that you’re going to buy soon, a money market fund is a safe place to grow your money.
4. Short-term corporate bond funds.
Bonds, in general, are similar to CDs. An exception is that they, just as stocks, are securities that trade in the market.
So, they may fluctuate in value, but not as much as stocks.
Bond funds are a collection of bonds from companies (large, medium, or small) from different industries. Hence, the name “corporate bond funds.”
Investing in bond funds can be used as a short-term investment. Sometimes, investors consider corporate bond funds to diversify their investment portfolio.
Just like a money market fund, corporate bond funds are not FDIC insured. But they are just as safe as a money market fund.
Plus, you don’t just invest in one bond or two bonds. If one bond in your investment fund takes a hit, it only affects a small amount of your money.
So while they are riskier than money market funds saving accounts, CDs, short term corporate bonds pay you more. That makes them one of the best short-term investments out there.
5. Treasury bonds.
One of the best ways to invest money in the short term is to buy treasury bonds. Treasury bonds are issued by the U.S. government.
There are three types: treasury bills, treasury notes, and treasury bonds. They are like CDs. Once the bond matures, you get the full money invested, plus interest.
Treasury bonds may provide the same or a better interest rate than CDs. But a big advantage is that, while they’re not FDIC insured, they are backed by the U.S. government.
In other words, the government promises to repay your money, which is considered to be very safe.
So if you have more than $250,000, you should consider a treasury bond.
Another advantage is that while interest on a CD is fully taxable, Treasury’s interest is state-tax-free.
In conclusion, short term investments are those in which you make for a certain and short period of time for a specific goal.
Short term investments aren’t the best if you’re seeking high returns.
But if you’re a beginner investor you should consider placing some of your money into these best short term investments.
Remember: don’t invest your money in stocks when you plan to use it within the next five years, because a stock market drop can dry out your investment portfolio.
Speak with the Right Financial Advisor
If you have questions beyond short-term investments, you can talk to a financial advisor who can review your finances and help you reach your goals (whether it is making more money, paying off debt, investing, buying a house, planning for retirement, saving, etc). Find one who meets your needs with SmartAsset’s free financial advisor matching service. You answer a few questions and they match you with up to three financial advisors in your area. So, if you want help developing a plan to reach your financial goals, get started now.
your financial details.
Savings bonds can be a safe way to save money for the long term while earning interest. You might use savings bonds to help pay for your child’s college, for example, or to set aside money for your grandchildren. Once you redeem them, you can collect the face value of the bond along with any interest earned. It’s important to realize, however, that interest on savings bonds can be taxed. If you’re wondering, how you can avoid paying taxes on savings bonds there are a few things to keep in mind. Of course, one key thing to keep in mind is that a financial advisor can be immensely helpful in minimizing your taxes.
How Savings Bonds Work
Savings bonds are issued by the U.S. Treasury. The most common savings bonds issued are Series EE bonds. These electronically issued bonds earn interest if you hold them for 30 years. Depending on when you purchased Series EE bonds, they may earn either a fixed or variable interest rate.
You can buy up to $10,000 in savings bonds per year if you file taxes as a single person. The cap doubles to $20,000 for married couples who file a joint return. If you decide you want to use some or all of your tax refund money to purchase savings bonds, you can earmark an additional $5,000 for Series I bonds. These are paper bonds, not electronic ones.
When Do You Pay Taxes on Savings Bond Interest?
When you’ll have to pay taxes on Treasury-issued savings bonds typically depends on the type of bond involved and how long you hold the bond. The Treasury gives you two options:
- Report interest each year and pay taxes on it annually
- Defer reporting interest until you redeem the bonds or give up ownership of the bond and it’s reissued or the bond is no longer earning interest because it’s matured
According to the Treasury Department, it’s typical to defer reporting interest until you redeem bonds at maturity. With electronic Series EE bonds, the redemption process is automatic and interest is reported to the IRS. Interest earnings on bonds are reported on IRS Form 1099-INT.
It’s important to keep in mind that savings bond interest is subject to more than one type of tax. If you hold savings bonds and redeem them with interest earned, that interest is subject to federal income tax and federal gift taxes. You won’t pay state or local income tax on interest earnings but you may pay state or inheritance taxes if those apply where you live.
How Can I Avoid Paying Taxes on Savings Bonds?
Whether you have to pay taxes on savings bonds depends on who owns it. Generally, taxes are owed on interest earned if you’re the only bond owner or you use your own funds to buy a bond that you co-own with someone else.
If you buy a bond but someone else is named as its only owner, they would be responsible for the taxes due. When you co-own a bond with someone else and share in funding it, or if you live in a community property state, you’d also share responsibility for the taxes owed with your co-owner or spouse.
Use the Education Exclusion
With that in mind, you have one option for avoiding taxes on savings bonds: the education exclusion. You can skip paying taxes on interest earned with Series EE and Series I savings bonds if you’re using the money to pay for qualified higher education costs. That includes expenses you pay for yourself, your spouse or a qualified dependent. Only certain qualified higher education costs are covered, including:
- Some books
- Equipment, such as a computer
You can still use savings bonds to pay for other education expenses, such as room and board or activity fees, but you wouldn’t be able to avoid paying taxes on interest.
Additionally, there are a few other rules that apply when using savings bonds to pay for higher education:
- Bonds must have been issued after 1989
- Bond owners must have been at least 24 years of age at the time the bonds were issued
- Education costs must be paid using bond funds in the year the bonds are redeemed
- Funds can only be used to pay for expenses at a school that’s eligible to participate in federal student aid programs
If you’re married you and your spouse have to file a joint return to take advantage of the education exclusion. And any money from a savings bond redemption that doesn’t go toward higher education expenses can still be taxed at a prorated amount.
There are also income thresholds you need to observe. For 2020, single tax filers can earn up to $82,350 and benefit from the full exclusion. Married couples filing jointly can do so with up to $123,550 in income. Once your income passes those limits, the amount of interest you can exclude is reduced until it eventually phases out altogether.
Roll Savings Bonds Into a College Savings Account
Another strategy for how to avoid taxes on savings bond interest involves rolling the money into a college savings account. You can roll savings bonds into a 529 college savings plan or a Coverdell Education Savings Account (ESA) to avoid taxes.
There are some advantages to either approach. With a 529 college savings plan, you can continue saving money on a tax-advantaged basis for higher education. You won’t pay any taxes on money that’s withdrawn for qualified education expenses. And if you have multiple children, you can reassign the account to a different beneficiary if one child decides he or she doesn’t want to go to college or doesn’t use up all the money in the account.
Contributions to 529 college savings accounts aren’t tax-deductible at the federal level, though some states do allow you to deduct contributions. You don’t have to live in any particular state to invest in that state’s 529 and plans can have very generous lifetime contribution limits. Keep in mind that gift tax exclusion limits still apply to any money you add to a 529 on a yearly basis.
Coverdell ESAs have lower annual contribution limits, capped at $2,000 per child. You can only contribute to one of these accounts on behalf of a child up to their 18th birthday. Withdrawals are tax-free when the money is used for qualified education expenses. But you have to withdraw all the funds by age 30 to avoid a tax penalty.
The Bottom Line
Savings bonds typically offer a lower rate of return compared to stocks, mutual funds or other higher-risk securities. But they can be a good savings option if you want something that can earn interest over the long term. Minimizing the taxes you pay on that interest may be possible if you have children and you plan to use some or all of your savings bonds to help pay for college. Talking to a tax professional can also help with finding other college tax savings strategies.
Tips for Investing
- Consider talking to a financial advisor about the best ways to manage savings bonds in your portfolio. If you don’t have a financial advisor yet, finding one doesn’t have to be difficult. SmartAsset’s financial advisor matching tool can make it easy to connect with professional advisors locally in just minutes. If you’re ready, get started now.
- Savings bonds purchased on behalf of grandchildren don’t receive the same tax treatment for higher education purposes. Generally, the education exclusion only applies if the grandparent is claiming a grandchild on their taxes as a dependent. If your parents are interested in helping pay for your child’s college expenses, you may encourage them to open a 529 college savings account instead, then roll the bonds into it to avoid paying taxes on interest earned.
Photo credit: ©iStock.com/JJ Gouin, ©iStock.com/stockstudioX, ©iStock.com/larryhw
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For investors with short-term saving goals, short-term bonds can be appropriate investments for your money.
They are stable and they certainly provide a higher return than a money market fund.
However, even with the best short term bond funds, there’s also a risk of losing a percent or two in principal value if interest rates rise.
There are many options available to you, but your best option is to invest in taxable short-term bond funds, U.S. Treasury short-term bond funds and federally tax-free bond funds.
What are short-term bonds?
Short-term bonds, or any bonds for that matter, are debts instruments that companies and the government issue. They typically mature in 1 to 3 years.
When you buy a bond, you are essentially lending money to the issuing company or government agency.
They are obligated to pay back the full purchase price at a particular time, which is called the “maturity date.”
Short-term bonds are low risk investments and you can have access to your money fairly quickly.
As with all bond funds, one of the risk of short term bond funds is that when interest rates rise, the prices of the bonds in the fund decrease.
But short term bond funds have a reduced risk of default, because the bond funds are backed by the full faith and credit of the U.S. government.
Moreover, because the term is short, you will earn less money on it than on an immediate-term or long term bond fund.
Nonetheless, they are still competitive and produce higher returns than money market funds, Certificate of Deposits (CDs), and banks savings accounts. And short-term bonds are more stable in value than stocks.
At a minimum, don’t buy a short-term bond fund if you’re saving for retirement or if you want to hold your money longer.
If you’re looking to invest your money for the long term and are still looking for safety, consider investing in Vanguard index funds.
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Short-term bonds: why do you need to invest in them?
You should invest in short-bonds if you intend to use the money in a few years or so. However, don’t push your emergency cash into bonds. That is what a bank savings account is for.
Also, you should not put too much of your long term investment money into bonds, either. If you have a long term goal for your money, it’s best to invest in mutual funds such as Vanguard mutual funds, real estate, or your own business.
Here are some situations where you should invest in short term bonds.
- You want to stabilize your investment portfolio. If you have other aggressive investments, you may need to balance it out with short term bond funds. The reason is because short term bonds are safer comparing to stocks.
- Buying a house.
- Retirement. If you’re thinking of retiring in a few years, short-term bonds are appropriate.
- Purchasing a car.
- You’re a conservative investor. Not all investors can stomach the risk of losing all of their money due to the market volatility. So instead of investing in stocks, which falls on the riskier end of the securities spectrum, you should invest in short term bond funds.
Best short-term bond funds to consider:
Most people prefer to buy bonds through a broker such as Vanguard or Fidelity.
If you’re looking for the best short-term bond funds to buy now, consider these options:
- Vanguard Short-Term Treasury Index Fund Admiral Shares (VSBSX)
- Vanguard Limited-Term Tax Exempt Fund Investor Shares (VMLTX)
- The Fidelity Short Term Bond Fund (FSHBX)
- Vanguard Short-Term Tax-Exempt Fund Investor Share (VWSTX)
- Vanguard Short-Term Investment Grade fund (VFSTX)
- T. Rowe Price Short-Term Bond Fund (PRWBX)
- Vanguard Short-Term Bond Index Fund (VBIRX)
Tax free short-term bonds
There are some short-term bond funds that are both state and federally tax free. But there are not too many out there.
However, the ones that are available are good investments. So, if you are in a low state bracket and in a high federal bracket, consider investing in these Vanguard bond funds.These are federally tax free bond funds:
Vanguard Limited-Term Tax Exempt Fund Investor Shares (VMLTX)
This Vanguard bond fund seeks to provide investors current income exempt from federal taxes. The fund invests in high-quality short-term municipal bonds.
This bond fund has a maturity of 2 years. So, if you are looking for a fund that provides modest income and is federal tax-exempt, the Vanguard Limited-Term Tax Exempt Fund is for you.
The fund has an expense ratio of 0.17% and a minimum investment of $3,000. This makes it one of the best short term bonds to buy.
Vanguard Short-Term Tax-Exempt Fund Investor Share (VWSTX)
Like the Vanguard Limited Short Term fund, this fund also provides investors with current income that is exempt from federal income taxes.
The majority of the fund invests in municipal bonds in the top three credit ratings categories. It also invests in medium grade quality bonds.
This fund too has an expense ratio of 0.17% and a minimum investment of $3,000, making it one of the best short term bond funds.
U.S Treasury Short-term Bond Funds: Vanguard Short-Term Treasury
If you’re interested in a bond fund that invests in U.S. Treasuries, then U.S.Treasury bond funds are a great choice for you. One of the best U.S.Treasury bond funds is the Vanguard Short-Term Treasury.
This bond fund seeks to track the performance of the Bloomberg Barclays US Treasury 1-3 Year Bond Index. The Vanguard Short-Term Treasury invests in fixed income securities with a maturity between 1 to 3 years.
This bond fund has an expense ratio of 0.07% and an initial minimum investment of $3,000. Currently, this short term bond fund has a 1-year yield of 4.51%, making it one of the best short term bond funds.
Of note, this fund is also available as an ETF, starting at the price of one share.
The Fidelity Short-Term Bond Fund (FSHBX)
The Fidelity Short Term Bond Fund is one of the best out there for those investors who want to preserve their capital. This fund was established in March of 1986 and seeks to provides investors with current income.
The fund managers invests in corporate bonds, U.S. Treasury bonds, and assets backed securities. Over the last 10 years, this bond fund has a yield of 1.98% and a 30-day yield of 1.98%. This Fidelity bond fund as an expense ratio of 0.45%. There is no minimum investment requirement.
Taxable short-term bond funds: Vanguard Short-Term Investment Grade fund (VFSTX)
If you are not in a high tax bracket, then you should consider investing in a taxable short term bond fund. One of the best out there is the Vanguard Short-Term Investment Grade fund.
This bond fund provides investors exposure to high and medium quality investment grade bonds, such as corporate bonds and US government bonds. This fund has an expense ratio of 0.20% and an initial minimum investment of $3,000, making it one of the best short term bond funds out there.
T. Rowe Price Short-Term Bond Fund (PRWBX)
The T. Rowe Price Short-Term Bond Fund invests in diversified portfolio of short term investment-grade corporate, government, asset and mortgage-backed securities. This bond fund also invests in some bank mortgages and foreign securities. This fund produce a higher return than a money market fund, but less return than a long-term bond fund. The T. Rowe Price Short-Term Bond Fund has a minimum investment requirement of $2500, making it one the most favorite short term bond funds out there.
Vanguard Short-Term Bond Index Fund (VBIRX)
The Vanguard Short-Term bond is a good choice for the conservative investor. It offers a low cost, diversified exposure to U.S. investment-grade bonds. This has fund has a maturity date between 1 to 5 years. Moreover, the fund invests about 70% in US government bonds and 30% in corporate bonds. The bond fund as an expense ratio of 0.07% and a minimum investment requirement of $3,000.
How to Invest in Short-Term Bonds
If you’re considering in investing in these or any of Vanguard bond funds, you need to do your due diligence.
First, think about what you need the bond fund in the first place. Is it to diversify your investment portfolio?
Are you a conservative investor who need a minimize risk at all cost? Or, do you want to invest in a short term bond fund because you need the money to use in a few years for a vacation, buying a house, or planning for a wedding?
Once, you have come up with answers to this question, the next step is to do your research about the best bond fund available to you.
Use this list to start. If it’s not enough, do your own research.
Look into how much the initial minimum investment is to buy a bond fund. Most Vanguard short term bond funds require a $3,000 minimum deposit.
Some Fidelity bond funds, however, have a 0$ minimum deposit requirement.
Next compare expense rations, performance for different funds to see if they match your investment goals. But you have to remember that past performance is not an indication of future performance.
Your final step is to open an account to buy your bond funds. If you choose Vanguard, you can do so at their website.
How do you make money with short-term bonds?
You can make money with short-term bonds the same ways you make money with a mutual fund (i.e., dividends, capital gains, and appreciation). But most of your returns in a bond fund comes from dividends.
In brief, short-term bonds are great investment choices if you have short term saving goals. You may be interested in buying these bonds because you expect to tap into your investment within a few years or so. Or, you want a more conservative investment portfolio.
Short term bonds produce higher yields than money market funds.
The only problem is that the share prices can fluctuate. So, if you don’t mind market volatility, you may wish to consider short-term bonds.
Speak with the Right Financial Advisor
- If you have questions beyond short-term bonds, you can talk to a financial advisor who can review your finances and help you reach your goals (whether it is making more money, paying off debt, investing, buying a house, planning for retirement, saving, etc).
- Find one who meets your needs with SmartAsset’s free financial advisor matching service. You answer a few questions and they match you with up to three financial advisors in your area. So, if you want help developing a plan to reach your financial goals, get started now.