M is for Money

Would you gamble with the money you need to live on tomorrow? Do you keep your nest egg stashed under the mattress? There is an appropriate place to keep each type of savings, depending on when you will need the money. Where do you keep the money you are saving for a house or for retirement? Should you keep both pots of money in the same place? The money you need to buy that new house next year should not be invested in the market and the money you need for retirement should not be languishing in a bank account. Different strategies are needed that mirror your timeline.

Bank for Tomorrow

The money you need in the next few years can’t be invested in something as uncertain as the stock market. You don’t have enough time to recover any losses from a down economy, but you do still have choices on where to keep your money in the meantime. Online savings accounts are a great alternative to your local mega-bank’s account. You get similar flexibility but with a higher interest rate. There are also money market accounts (MMAs) that offer a slightly higher return with minimal risk. If you can do without instant access to that money, you can look at Certificate of Deposits (CDs). They offer risk free return in exchange for a fixed period of time, there will be penalties and loss of interest if you withdraw the money early. Say you want to buy a house in 3 years, a 3 year CD matches perfectly with your time horizon. But one note – now is a terrible time to take out a CD. Rates are very low, you are better off putting the money in a high yield online savings account until rates rebound, which will probably happen well before that low rate CD matures.

Look beyond your local big bank as well. Not only do online banks offer better rates on checking, savings and CDs, your local credit union may as well. There are many online resources like bankrate.com to help you shop rates and products.

Invest for the Future

The answer is fairly obvious for the long term dreams like retirement, the money should be invested in the market. Not all of it necessarily, you should add in bonds and perhaps some cash to balance out the risk. But provided your horizon is 15 years away, your choice is clear. With 15 years to recover from any losses, the balance tips in favor of risk. Why not aim for a return that will put your money to work, beat inflation, and get you to your goals? But this approach is a disaster when you only have a few years to that goal, a downturn could completely wipe you off course. You can start investing with very little money in taxable or retirement accounts. In this case, time is on your side.

The Dilemma of In-Between

To me, the hardest decision to make is what to do with the in-between years, goals that are 5 to 15 years away. It’s too close to risk losing it all in the market, yet far enough away that you need the market’s high returns. My own approach is a blended one, some mutual funds along with more bonds and cash. But I tend towards riskier investments, you might be more comfortable sticking to long term CDs or bonds. This dilemma, risk when you have an intermediate time frame, makes for tricky money management.

An Amateur Mistake

One of the top mistakes amateur investors make is choosing the wrong investment for their time frame. They’ll put their emergency fund in emerging market funds or let fear rule and put retirement money in a MMA. Neither strategy is sound, there are better ways to match your investments to your time horizon. Risk is best left to long term goals, when you’ll have time to recover from any major losses. Cash is king when it comes to immediate needs, but its value gets eroded over time due to inflation. Matching your money management to your time horizon allows you to more safely invest in the market while preserving your savings when you need them.


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