Are you investing for the near-term, say five years or less? Or for a longer period? Your answers should guide how you invest your portfolio. This article shows how to do it. Used in concert with our Best-Invest calculator, the ideas below can help you craft a portfolio that is aligned with your goals, matched to your the time-horizon, and built from high-quality, low-cost funds.
A Portfolio's Term
Your portfolio, whatever its purpose, must fit your timetable. To be sure, you may have limits on how much variation you will accept, up or down, in your portfolio's market value. But within your tolerable range, you can and should invest your assets very differently if you plan to spend them on, say, your own 25-year retirement beginning fifteen years from now or on a child's college education in four years. Even the most cautious investor should invest more in stocks for longer-term goals; even the most enterprising should put more in bonds and cash for shorter-term goals.
At able2pay.com, we recommend four shifts that should occur in your portfolio as your time-horizon shrinks from later to sooner:
The rest of this article gives worked examples for specific time-horizons, explains the rationale for each example, and identifies firms with ready-made products that may, in some cases, be good solutions. Examples are drawn from a variety of low-cost firms, including Betterment, TIAA-CREF, Vanguard, Wealthfront, and iShares. You can find more information about these and other companies in our article Best Firms 2016.
At able2pay.com, we recommend four shifts that should occur in your portfolio as your time-horizon shrinks from later to sooner:
- The overall portion you allocate to stocks should decrease and be replaced by bonds.
- Investment in international stocks should diminish, vanishing completely when stocks overall are a distinct minority.
- Some of the declining portion of stocks should be replaced with corporate bonds.
- Your bond holdings should have fewer long-term government bonds and more short-term ones.
The rest of this article gives worked examples for specific time-horizons, explains the rationale for each example, and identifies firms with ready-made products that may, in some cases, be good solutions. Examples are drawn from a variety of low-cost firms, including Betterment, TIAA-CREF, Vanguard, Wealthfront, and iShares. You can find more information about these and other companies in our article Best Firms 2016.
Long-Term Example: Future Retirement
Suppose you are planning to retire in 15 years and expect to live 25 years past your retirement date. You want your portfolio to grow strongly, while limiting its volatility. Accordingly, your entries in the Best-Invest calculator are:
- Most important? Maximize gains
- Accept ups and downs? No
- Start spending how many years from now? 15
- Spend for how many years? 25
Investment | Allocation | Rationale |
---|---|---|
Stocks | ||
US Companies | 52 % | Stocks have much better long-term gains than bonds or cash. They tend to grow faster than the economy, and when held a decade or more have historically outpaced inflation. |
International Companies | 22 % | About a third of the U.S. economy depends on imports and exports. Investing a third of a portfolio's stocks internationally also tends to even out year-to-year performance. |
Bonds | ||
Long US Treasury | 26 % | U.S. Treasury bonds with maturities around 20 years are best at counterbalancing stocks, long-term. When one zigs, the other tends to zag. This helps to limit the portfolio's ups and downs. |
Cash | ||
Savings or Money Market | 0 % | It will be a long time before the money in this portfolio is spent. Holding any of it in cash would reduce gains and raise a risk of loss to long-term inflation. |
Several strategies are reasonable as ways to implement or approximate this portfolio. Here are some examples. They all work well.
- Index funds from Vanguard: 52% Total Stock Market Index, 22% Total International Stock Index, 26% either Long Term Treasury or Long Term Government Bond Index. In a taxable account, use Long Term Tax Exempt or a state-specific fund for bonds.
- Exchange Traded Funds (ETFs) from iShares: 52% Core S&P Total U.S. Stock Market, 22% Core MSCI Total International Stock, 26% 20+ Year Treasury Bond. In a taxable account, use National AMT-Free Muni Bond. You may be able to purchase these ETFs commission-free from firms such as Fidelity or TD Ameritrade.
- Specialized funds that apply academic research on factor-investing: 44% Vanguard Global Minimum Volatility or iShares MSCI All-Country World Minimum Volatility; plus 15% each in Vanguard Mid-Cap Value and Vanguard Small-Cap Value; and 26% in a long-term Treasury fund from options 1 or 2. Note that in this case, the minimum volatility funds are about 50% U.S. and 50% international; thus they cover all the international stocks in the portfolio, but only part of the U.S. stocks. Small-to-mid cap U.S. value index funds fill the remainder of the U.S. portion. To understand the research behind this portfolio, read the article Diversify!
- All-in-one portfolios: Alternatively, you could invest at Betterment or Wealthfront and set your stock-allocation to 76%, or you could purchase a balanced fund like Vanguard's LifeStrategy Growth. These are low-cost and they approximate the portfolio with just a single fund.
Mid-Term Example: Spending When Retired
Let's fast-forward your hypothetical life and assume you have been retired for some time. You are living comfortably on your savings, and, given your health, you expect to live four or five years longer. To be safe, you tell the calculator that you need the remainder of your retirement funds to last for a decade. Your inputs to the calculator are:
- Most important? Maximize gains
- Accept ups and downs? No
- Start spending how many years from now? 0
- Spend for how many years? 10
Investment | Allocation | Rationale |
---|---|---|
Stocks | ||
US Companies | 31 % | Because some assets will be spent in 6 to 10 years, stocks still get a decent allocation, as their growth prospects are good for that period. |
International Companies | 14 % | Given the overall allocation to stocks, a one-third portion for international companies is still big enough to be worthwhile. |
Bonds | ||
Long US Treasury | 15 % | U.S. Treasury bonds with maturities around 20 years continue to be a good counter-weight to the stock investments. |
International Hedged | 14 % | A modest allocation to international, dollar-hedged bonds will diversify your bonds and smooth your returns. |
1-5 Year U.S. Treasury or CD | 16 % | The portion assigned to short-term Treasuries is, in effect, a safe place for money to be spent two to three years from now. |
Cash | ||
Savings or Money Market | 10 % | Money to be spent in the immediate future is kept in cash. With 10 years to go, 10% is the payout to be spent this year. |
You could round the numbers to 30% in U.S. stocks, 10% in cash-equivalents, and 15% in each of the other areas. To build a portfolio exactly like the table above, you could use the same funds identified in the previous example, plus Vanguard's BNDX or VTIBX for international, dollar-hedged bonds, plus a fund of short-term treasury bonds and a money-market or bank-savings account. For an elderly retiree, however, an all-in-one fund might be attractive as a low-effort solution. Thus you might opt for one of the following:
- Bank CDs + Automated Portfolio: 26% of the assets in bank CDs ranging in maturity from 3 months to 2 years, and all the rest at Betterment or Wealthfront, with the stock-portion set at 61%, because (31 + 14) / (31 + 14 + 15 + 14) = 61.
- Vanguard: 10% in a money market fund, 16% in the Short Term Treasuries fund, and the rest in LifeStrategy Moderate Growth or Wellington Fund.
Mid-Term Example: College Four Years from Now
In this example, let's assume you have a savings account for a child who will start attending college four years in the future. It will take four additional years to spend down the account. Your preferred style of investing is the same as in the examples above, but the time-horizon is different. Your entries in the Best-Invest calculator are:
- Most important? Maximize gains
- Accept ups and downs? No
- Start spending how many years from now? 4
- Spend for how many years? 4
Investment | Allocation | Rationale |
---|---|---|
Stocks | ||
US Companies | 41 % | Stocks have better returns than bonds or cash over periods of 4-8 years. The portion allocated here strikes a balance between aiming for some growth and limiting a potential downturn. |
International Companies | 18 % | About a third of the U.S. economy depends on imports and exports. Investing a third of a portfolio's stocks internationally also tends to even out year-to-year performance. |
Bonds | ||
Long US Treasury | 18 % | U.S. Treasury bonds with maturities around 20 years counter-balance the stock investments, but also pay interest at rates that normally exceed inflation, if held several years. |
International Hedged | 12 % | A modest investment in international, dollar-hedged bonds would stablize the portfolio as it becomes more conservative; if not available, use a bond-index instead. |
1-5 Year U.S. Treasury or CD | 11 % | It's time to begin shifting some assets to conservative short-term Treasuries, which offer some protection against near-term inflation and are backed by the federal government. |
Cash | ||
Savings or Money Market | 0 % | With four years to go before any money is spent, it is too soon to move assets to a cash account. That would happen for funds to be spent within 12 to 18 months. |
For college-savings, you would most likely implement this portfolio within a tax-sheltered 529 plan. Below are examples based on TIAA-CREF's 529 Plan for California and Vanguard's 529 Plan for Nevada. These offer very low fees and are available to residents of any state.*
- Index funds in a Vanguard 529 Plan: 41% Total Stock Market Portfolio, 18% Total International Stock Index Portfolio, 30% Total Bond Market Index Portfolio, 11% Income Portfolio.
- All-in-one fund in a Vanguard 529 Plan: 100% in Moderate Growth Portfolio. Although the stock-allocation is somewhat lower than suggested by the calculator, the fees are exceptionally low.
- Index funds in a TIAA-CREF 529 Plan: 42% Index U.S. Equity Investment Portfolio, 18% Index International Equity Index Portfolio, 30% Index Bond Investment Portfolio, 11% Principal Plus Interest Investment Portfolio. Note that for TIAA-CREF, the guaranteed interest alternative, which they call "principal plus interest," is best matched to short-term Treasuries and cash.
Short-Term Example: Starting to Spend for College
Continuing the previous example, let's leap ahead four years and consider a college-savings portfolio as your hypothetical child finishes high school. Your answers to the calculator's questions would be:
- Most important? Maximize gains
- Accept ups and downs? No
- Start spending how many years from now? 0
- Spend for how many years? 4
Investment | Allocation | Rationale |
---|---|---|
Stocks | ||
US Companies | 20 % | A small allocation to U.S. stocks offers some growth and inflation-protection for the final two years of the student's college education. |
International Companies | 0 % | Because the overall allocation to stocks is very low, a fractional allocation to international stocks would add little value. |
Bonds | ||
Long Corporate | 10 % | A modest allocation to corporate bonds improves returns somewhat and diversifies the large allocation to U.S. Treasury bonds. |
International Hedged | 14 % | A modest investment in international, dollar-hedged bonds would stablize the portfolio; if not available, use a bond-index instead. |
1-5 Year U.S. Treasury or CD | 31 % | Short-term Treasuries dominate the portfolio because of their safety and because they tend to offer some protection against near-term inflation. |
Cash | ||
Savings or Money Market | 25 % | Each year the student is in college, money to be spent that year goes to cash: 25% in the 1st year, 33% in the 2nd, 50% in the 3rd, 100% in the 4th. |
The following examples are again based on TIAA-CREF's 529 Plan for California and Vanguard's 529 Plan for Nevada, which are available to residents of any state. They reasonably approximate what the table prescribes.
- Index funds in a Vanguard 529 Plan: 20% Total Stock Market Portfolio, 10% Total Bond Market Index Portfolio, 70% Income Portfolio. Note that Vanguard's Income Portfolio includes a mix of bonds and cash that approximates the suggested allocations for international dollar-hedged bonds, short-term Treasuries, and cash.
- All-in-one fund in a Vanguard 529 Plan: 100% in the Income Portfolio. Although the stock-allocation is zero, the rest of the allocations match those suggested by the calculator, and the fees are exceptionally low.
- Index funds in a TIAA-CREF 529 Plan: 20% Index U.S. Equity Investment Portfolio, 24% Index Bond Investment Portfolio, 56% Principal Plus Interest Investment Portfolio. TIAA-CREF's guaranteed interest alternative, which they call "principal plus interest," is again matched to short-term Treasuries and cash.
Disclaimer: Historical data cannot guarantee future results. Although a mixture of bonds, stocks, and other investments may be safer than investing exclusively in one class of assets, diversification cannot guarantee a positive return. Losses are always possible with any investment strategy. Nothing here is intended as an endorsement, offer, or solicitation for any particular investment, security, firm, or type of insurance. You are responsible for your own investment decisions. Please read our full disclosures and Fiduciary Oath.
* Under the rules for 529 College Savings Plans, each state administers a distinct plan, but residents from other states may be allowed to open accounts. The fees vary widely, depending on the vendor selected by the state, with all Vanguard plans and TIAA-CREF's index plans often having the lowest cost, especially in the states cited in this article. Some states offer a deduction from the state's income taxes if you invest in the state's 529 plan. Thus, the best strategy, if available to you, is to select a low-cost vendor in your own state, if your state offers a tax deduction. At their websites, both Vanguard and TIAA-CREF provide calculators to check whether you might benefit from your state's tax policy. Be mindful, however, about selecting a high-cost plan even if it offers a tax deduction; you may do better in a different state's low-cost plan, without a tax benefit.