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Investing for Non-Retirement Savings Goals

A reader writes in, asking:

You’ve written before about viewing all your accounts as one portfolio. What about when you have some money that’s not intended for retirement?

For example, I use an 80% stock, 20% bond allocation for my retirement savings, but I also have a good amount of money, currently in savings, that I expect to use somewhere between 5-20 years from now. What would be a good allocation for that money? And should that money be counted in my overall “one-portfolio” asset allocation? For example, if I put the money in CDs or a bond fund, would that have an impact on the allocation I should use for my retirement money?”

In my opinion, the easiest way to choose investments is on a goal-by-goal basis. For example, money intended for retirement savings has one asset allocation, money intended for your kids’ college education has another asset allocation, money intended for a home downpayment in a few years has another allocation, and your emergency fund has yet another allocation.

And (for the most part) those allocations are chosen independently of each other.

In other words, I would select an asset allocation for my retirement savings (using the all-one-portfolio idea to minimize costs and complexity), then I would separately select an appropriate asset allocation for each significant non-retirement savings goal.

How to Allocate for Shorter-Term Goals?

In general, the more near-term the goal you’re saving for, the less risk you can afford to take. I often use a very rough mental guideline that looks like this:

  • 0-5 years: 0% stock (e.g., CDs, savings account, money market),
  • 5-10 years: 20% stock (e.g., Vanguard LifeStrategy Income Fund),
  • 10-20 years: 40% stock (e.g., Vanguard LifeStrategy Conservative Growth Fund).

In other words, for any goals less than 5 years away, my personal inclination is to stick with things that are very safe, such as CDs. And for goals in the 5-20 year range, I think it starts to make sense to consider a modest stock allocation. But that comes with two huge caveats.

First, as we’ve discussed before, asset allocation is not a precise science. That’s every bit as true in the short-term as it is in the long-term.

Second, asset allocation should be determined by risk tolerance, and risk tolerance is about much more than just time frame. For example, there are additional economic factors to consider:

  • Is the dollar amount of your goal flexible, or is it absolutely crucial that you have at least as much money at the end of the period as you have at the beginning?
  • Is the time frame itself flexible? (For example, a home downpayment can often be put off for a few years without a terrible problem. But when your child reaches age 18, putting off college for a few years might not seem like a viable option.)

Then there’s the emotional component of risk tolerance as well: Could you take a 10% loss in stride, or would it cause a great deal of mental distress? What about a 20% loss? 30%? You’ll want to choose an allocation that accounts not only for the economic impact of a loss, but the emotional impact as well.

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  1. Question about investment goal term.

    For someone just entering retirement, there is not a single “term” for the goal. Some of the investment may need to pay out immediately and some maybe 30 years in the future. Perhaps an average of 15 years? Perhaps it needs to be weighted in one direction or another. Perhaps the relationship of asset-allocation to term is not linear.

    How does one apply you allocation guidelines to this situation?

  2. Good question, Bob.

    In short, the guidelines above are not intended for retirement at all, because, as you mentioned, retirement spans a very lengthy period (hopefully).

    Perhaps the most interesting look I’ve seen at retirement asset allocation comes from Wade Pfau (see charts here and here, for example). What you can see from the charts in Pfau’s articles is that, for modest withdrawal rates, there’s usually not much difference among middle-of-the-road allocations. For example, a 40% stock allocation looks about the same as a 60% stock allocation.

    Personally, my plan for retirement age is to satisfy my basic expenses with very safe sources of income (by delaying Social Security and/or buying inflation-adjusted lifetime annuities, for example). For any amounts left after doing that, any allocation from highly aggressive to highly conservative would be OK, depending on how I feel about risk at the time.

  3. Hey Mike,

    Great website.

    What are your thoughts on the tax implications of having mutual funds/ETFs with allocations of stocks/bonds/REITS in taxable accounts that one would typical have money they plan to use in 0-10 years. I mainly keep my short term (non-retirement) savings in savings accounts/checking/CDs because I am apprehensive about having mutual funds/ETFs with bond and REIT allocations because I have read the tax implications can be much different than just stock funds. Do you have any insight on this? Am I wrong? How do taxes for funds with Bonds/REITS work in taxable accounts?

  4. Hi John.

    It’s true that, in a taxable account, bonds (and, therefore, bond funds) are not as tax-efficient as stocks, because the interest is fully taxable, as compared to stocks which can provide tax-advantaged dividends and capital gains. It’s worth noting, however, that that applies just as much to CDs and savings accounts. Nothing that pays taxable interest is particularly tax-efficient.

    That said, it’s more important to have an appropriate level of risk than to have tax-efficient holdings. And short-term goals tend to require low-risk investments, which usually means that (tax-inefficient) CDs/bonds/savings are a better choice than (tax-efficient) stocks.

    As far as REITs, it’s true that they’re particularly tax-inefficient in taxable accounts because they distribute relatively large amounts of taxable income. But, given their risk level (which is approximately on par with other stocks), they tend not to make sense for short-term goals anyway.

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