Every investment you have should be tied to a financial goal.
If it’s tied to financial goal, then you know when you’ll need the money.
If you know when you’ll need the money, then you’ll know how to invest.
Here’s why…
You get “paid” a higher rate of return for investments that are most volatile.
For instance…
You get 1% in a savings account with no volatility.
You get 10% in a diversified portfolio of index funds with high volatility.
So you simply match up the volatility of an investment with how soon you need the money.
Need it real soon? Then it should be in cash.
Need it in 10 years? Then it should be in index funds.
But what if you need it between NOW and ten years from now?
Like for a down payment next year?
Then you invest in bonds (NOT BOND FUNDS*)
For the last 14 years, the line in the sand was two years.
If your financial goal was within two years, then you would earn a higher interest rate keeping it in a savings account.
If it was between 2-10 years, then you would earn a higher interest rate (or “yield”) in bonds (NOT BOND FUNDS*).
However, due to the Fed raising interest rates, the line in the sand has been redrawn. It’s now 6 months.
You can earn 1% in a high yield savings account right now
OR you can earn 1.8% on a 6 month bond.
Investing “correctly” is a two step process:
1) Matching the volatility of an investment with the financial goal
2) Maximize the return for the acceptable level of volatility
*Bond funds fluctuate with the underlying market value of the bonds and you can/will lose money when interest rates rise.
