It's almost the end of another year -- a good time to reflect on the accomplishments of the previous months and start setting goals for the new year, including financial ones. To be successful, it's important to know the "when" of your financial goals. That's because your financial strategy will vary depending on how long you plan to keep your money invested. Most goals fit into one of the three categories below.
Short-term goals (less than three years)
The closer you get to your goal, the less risk you generally want to take with the money you've already accumulated to pay for it. Because you plan to spend the money you set aside for short-term goals relatively quickly, you'll want to focus on safety and liquidity, rather than growth, in your short-term portfolio. For this reason, it's often a good idea to put your money into federally insured bank or credit union accounts or cash-equivalent investments, which aren't likely to lose much value in six months or a year. Liquid investments are those you can sell easily with little or no loss of value, such as Treasury bills, money market accounts and funds, and other low-risk investments that pay interest.
Consider alternatives that don't impose potential penalties or fees for accessing your money before a maturity date. For example, a five-year CD might be safe, but the early-withdrawal penalty is likely to cut into your money.
Mid-term goals (three to 10 years)
Choosing the right investments for mid-term goals can be more complex than those for short- or long-term goals. That's because you need to strike an effective balance between protecting the assets you've worked hard to accumulate and achieving the growth that can help you build your assets and offset inflation.
Mid-term goals are typically those for which you need time to accumulate the money. The more time you have, or the more flexible the timing, the more risk you can probably afford to take with your money. For example, you might want to invest some of your assets in stocks, either directly or through mutual funds or exchange-traded funds (ETFs), because of the potential for a higher return that would allow you to reach your goals sooner. As the time frame for those goals gets shorter, you can gradually move some of those assets into more price-stable investments.
Long-term goals (more than 10 years)
For many people, the No. 1 long-term goal is a financially secure retirement. And that's a goal with a very long time horizon. When your goal is paying for college, for example, you think in terms of paying costs for four years -- or perhaps a few more for a post-graduate or professional degree. But when you think about retirement, you have to think in terms of managing expenses for 15, 20, 30, or maybe even 40 years. Since you'll need income for that entire period, it's important to make your money work for you, and this means earning a rate of return that outpaces inflation and allows your principal investment to grow over time.
The general rule is that the more time you have to reach a financial goal, the more investment risk you can afford to take. For many investors, that can mean allocating most of the principal you set aside for long-term goals to growth investments, such as individual stock, stock mutual funds, and stock ETFs. Over time, you can gradually shift a greater percentage of your accumulated account value into income-producing investments such as bonds.
While past performance is no guarantee of future results, historical returns consistently show that a well-diversified stock portfolio can be the most rewarding over the long term. It's true that over shorter periods -- say, less than 10 years -- investing heavily in stock can lead to portfolio volatility and even to losses. But when you have 15 years or more to meet your goals, you have a good chance of being able to ride out market downturns and watch short-term losses eventually be offset by future gains.
Keep in mind that no goal is short-, medium- or long-term forever, and so the timetable for your financial goals will evolve over time. For instance, retirement will be a long-term goal when you're 35, but it will probably be a short-term goal when you're 65. Similarly, paying for your child's higher education will be a long-term goal when she's a baby, but a short-term goal when she's a high-school sophomore. So your investing approach -- and choices -- should evolve as you draw closer to each of your goals.
If you have already set aside funds for short-, medium-, or long-term goals, then the end of 2016 is a good time to see if the saving and investment products you selected still represent the right balance of risk and return as we head into a new year.