I have to apologize to the younger readers of Mindfully Investing because I’ve probably focused my posts too much on long-term investing for retirement.  For the most part, I haven’t written much about mindful investing for more short-term goals like a downpayment on a house, a business enterprise, or a child’s college education.  So, today I’m going to correct that omission and describe a mindful approach to short-term investing.

What Is Short-Term Investing?

It’s pretty well established that stocks have historically outperformed the other major asset classes of bonds and cash over most multi-year timespans.  And historical data suggest that, if held for a decade or more, broad stock index funds have only a negligible chance of losing money.  That’s why long-term mindful investing emphasizes a heavy or even exclusive allocation to stocks.

Using that information, we can define short-term investing as when you expect to spend your invested money less than 10 years in the future.  With a timeframe of less than a decade, relatively poor performing but less volatile bonds and cash start to show their merits.  For example, if you plan to invest in stocks for five years and the stock market crashes in year four, you could be in real danger of having less money available to spend than you originally invested.  That sort of volatility rodeo rarely happens with bonds and never happens with cash.

I thought about some short-term investment goals that typically take less than a decade, and I came up with these examples:

• Marriage and/or wedding expenses
• A big toy purchase (cars, boats, RVs, home furnishings, home improvements, dream travel, etc.)
• Higher education expenses for yourself
• Supporting elderly relatives (reverse inheritance)
• Downpayment on a house, vacation property, or rental property
• Starting or investing in a business
• Health expenses or funding a health savings account (HSA)
• Higher education expenses for children.

Because these near-term life goals don’t offer us the luxury of time, saving and investing for them can be more complicated than just investing in low-cost stock index funds.

Measuring Short-Term Risks

To start simply, let’s examine the chances of losing inflation-adjusted money on each of the three major asset classes as shown in this graph using historical data from 1928 through 2020¹.

These historical data support my earlier statement that the chances of losing inflation-adjusted money with stocks over a 10-year timeframe are pretty low (about 10%).  But the chances of a loss with bonds and cash are higher, almost regardless of how long you hold them.  That’s because the relatively poor returns of bonds, and particularly cash, have a difficult time keeping pace with long-term erosive effects of inflation.

This graph also shows that bonds and cash perform relatively similarly over time; they both exhibit low volatility and relatively low returns.  Further, right now the likely returns from intermediate-term bonds (5-10 year maturities) and cash are remarkably similar.  For example, the current yield on a 7-year bond is only 1.24%² and the interest on a 5-year bank certificate of deposit (CD) is 0.95%.  So, we can simplify the analysis of short-term investing by considering bonds and cash one asset class that I sometimes refer to as “ballast”.  Ballast steadies your portfolio, but it rarely boosts its performance.

Next, we need to consider the magnitude of losses typically involved with holding stocks versus ballast like bonds and cash.  The magnitude of potential losses is most often measured using routine “volatility“.  But long time readers know that “permanent loss” is a better measure of investing risk.  Permanent loss risk can be calculated by multiplying the chances of a loss over any given timeframe (from the graph above) times the magnitude of the potential loss based on historical data.  This graph shows the permanent loss risk for stocks versus bonds over various timeframes.

The vertical axis is expressed here as a “percent”, but it’s specifically a percent chance of a loss times the percent of negative return potential for each asset.  So, it’s best to simply think of it as a unitless measure of risk that can be used to make relative comparisons between two or more assets³.

More to the point, the graph shows that after about 7 to 10 years of investing, the risk from stocks is about equal to the risk from bonds.  Given historical data are always somewhat noisy, I smoothed out the stock line using a best-fit linear regression (dotted blue line), which further confirms that year 10 is a good estimate of when the risks of stocks and bonds equalize.

A Mindful Short-Term Asset Allocation

It’s easy to conclude from these data that you should invest only in bonds/cash if your investment timeframe is less than a decade, and you’ll find many articles on the web that make that sort of generic recommendation.  But I think we can come up with a better solution for mindful short-term investors as shown in this graph.

The purple line describes an implied mix of stocks and bonds/cash that keeps the permanent loss risk steady at 2.2 over timeframes between one and eight years.  That is, a permanent loss risk estimate of 2.2 is the relatively “safe” level of risk that a “risk-averse” investor in a 10-year T-Bond is willing to accept for a one-year investment.  So, what if we could add in some higher-performing stocks to a portfolio with these timeframes and maintain a similar level of “safety”?

It turns out that we can exactly trace that purple line with the mix of assets shown in this graph.

So, if you need to save and invest for some goal that is two years away, the historical data suggest that a portfolio of 18% stocks and 82% bonds/cash is only a little bit riskier than holding 100% bonds/cash.  And more interestingly, if your goal is, for example, seven years away, you can hold something closer to 50% in stocks with very little added risk.

It’s important to note that this graph shows the mindful portfolio for each investment timeframe, assuming that you hold the portfolio for that full period.  It does not show how your portfolio would change over time as the years of investing progress.  Consequently, if you are uncertain about how long you can hold your short-term investment, it’s best to pick an asset mix that underestimates your most likely investment timeframe.

Also, if you’re saving and investing in increments over time, as most people usually do, this approach requires that you maintain this same mix of assets from the beginning to the end of your investing timeframe.  For example, if your stocks grew a lot in the previous year but bonds/cash performed poorly, you might need to buy more bonds/cash the next year to maintain (rebalance to) the same asset mix over time.

Matching Asset Mixes to Short-Term Goals

The final step to picking a mindful short-term asset mix is figuring out how long your investment timeframe is going to be.  I can’t tell you what your particular timeframe is for a particular goal you might have in mind.  You’ll need to figure out a timeframe that’s most realistic for your specific situation by at least considering these steps:

• How much money do you need for the goal? – For example, maybe you want a 20% downpayment on a house of about $400,000, which is $80,000.
• How much can you save and invest each month or year? – Maybe with your salary and living expenses you can afford to sock away $1000 per month, which would be $12,000 per year.
• Divide your goal by your annual saving rate as a starting point – Using the same example, an $80K goal divided by a $12K per year gives you a rough estimate of 7 years of saving/investing.

Of course, this last step ignores any returns generated by the invested money.  This set of pie charts shows the mindful short-term asset mix for every investing timeframe between one and eight years along with an estimate of the expected average annual return for that portfolio.

To get these expected return estimates, I assumed the stock portion of each portfolio would return 9% nominal per year on average, which is based on the history of the S&P 500.  And I assumed the bonds/cash portion would provide an annual return equal to the yield of a bond or cash instrument with a duration consistent with the portfolio timeframe.  I used the current returns on high yield savings accounts, bank certificates of deposits (CDs), short-term Treasury Bills, and intermediate-term Treasury Bonds.⁴

For one example, for the 1-year portfolio, I used the current yield of a 1-Year CD of 0.65% for the bonds/cash portion of the portfolio.  And as another example, for the 5-year portfolio, I used the current yield of the 5-Year Treasury Bond of 1.24%.

Making Your Own Estimates

You can use the expected returns for these portfolios to refine your timeframe for any particular short-term investing goal.  If you don’t like doing the calculations yourself, you can use a calculator like this one from Bankrate that allows you to input monthly or annual saved/invested amounts (contributions) and specify the expected annual rate of return.

Finishing off the example from above, the Bankrate calculator shows that with the expected annual returns from the 6-Year portfolio of 3.96%, our theoretical house saver would accumulate $82K with $1,000 monthly contributions in exactly 6 years.  In other words, the 6-Year portfolio is probably a good one for our theoretical saver, or perhaps the 5-Year portfolio if there is uncertainty about exactly when that house will be bought.

The Bankrate calculator also shows that of the $82K generated in our example, only $9,200 is due to investment returns.  This is yet another great reminder that how well you save is way more important than how well you invest.

I made some timeframe estimates for the other short-term investing goals listed at the top of this post based mostly on my financial history, with the key statistics for each goal shown in this table.

Investing Goal	Example No. of Years	% Bonds/Cash	% Stocks	Avg. Annual Return
Marriage Expense	2	82%	18%	2.2%
Big Toy Purchase	3	79%	21%	2.6%
Higher Education – Self	4	76%	24%	2.9%
Supporting Relatives	5	72%	28%	3.4%
Property Purchase	6	65%	35%	4.0%
Business Investment	7	52%	48%	5.1%
Health Expense	8	25%	75%	7.1%
Higher Education – Kids	10	0%	100%	9.0%

Again, I need to stress that the timeframes in this table are only examples.  Perhaps, you plan to get married in a year and haven’t started saving for a wedding, rings, honeymoon, etc.  In that case, no math in the world is going to tell you what you already know.  You will have to save as much as you can, use something like the 1-Year portfolio, and simply limit your marriage expenses to what you can afford in a year from now.

One other huge caveat is that the average annual expected returns here aren’t guarantees of anything.  This is particularly true of the stock portion of these portfolios, given that stocks can diverge substantially in any given period from the historical average of 9% nominal return.  In contrast, if you invest in a 5-Year Treasury Bond fund yielding 1.2% today, you can be relatively certain that you’ll receive a total annual return of around 1.2% when the five years is over².  But even funds based on Treasury Bonds experience some unpredictable price/yield volatility, which means your annualized return could vary by a noticeable amount.

Conclusions

Hopefully, I’ve provided some concrete ideas about how to mindfully approach short-term investing goals.  I intended to go beyond the typical and unhelpful platitudes like, “invest it someplace safe unless you’re risk averse”, which are all too common in the media.

On the other hand, I have to remind everyone that the information at Mindfully Investing is not advice.  Mindfully Investing is founded on four principles, one of which is that investors should not take the words of experts (or me) at face value.  Rather, mindful investors conduct their own homework and do their own thinking before making any investment decisions.

It’s very possible that using some of these portfolios could result in a loss of capital.  My suggested approach is to minimize risk over short-term timeframes, but risk cannot be eliminated in investing (or in most other things).

So, if the idea of losing some of your hard-earned and assiduously saved money by including stocks in your short-term portfolio vexes you sorely, then you should probably just go with a high-yielding savings account and be done with it.  After all, the math in this post has reminded us yet again that saving diligently is way more important than the most optimized investing plan ever devised.

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1 – For this post, I’m using Shiller stock data and Damodaran data for bonds and cash.  Stocks are represented by the S&P 500, bonds by the 10-Year Treasury Bond, and cash by 3-Month Treasury Bills.

2 – The best predictor of a bond’s total return over the life of that bond is its starting yield.

3 – Otherwise there’s room for confusion, where people look at graphs like this and think that it means they can only lose 2% to 4% of their investment over a year or two timespan.  That’s definitely the wrong way to use this information because short-term losses from stocks and even bonds can be much larger.

4 – Another short-term cash/bond possibility is Treasury Inflation-Protected securities or TIPs.  For example, this year to date Vanguard’s TIPs fund (VIPSX with an average duration of 7.6 years) is up 4.3%, while the 10-Year Treasury Bond return is down -3.9%.  Generally, TIPs perform well relative to conventional Treasury bonds when inflation goes up, like it has this year, and perform relatively poorly when inflation goes down.  For example, VIPSX has outperformed 10-Year T-Bonds in 12 out of the last 21 years, which is a little better than a coin flip.  Given that many experts are expecting the current spike of over 6% inflation to subside, this may be a relatively risky time to invest in TIPs.  But no one knows where inflation will go next for sure, and protecting against inflation uncertainty is the main reason that TIPs exist in the first place.