Short term vs. Long term savings

• Short term vs. Long term savings
  • Short term
  • Long term
  • How to save for each

Short term

What defines short term is, frankly, opinion. Mine is that anything less than 5 years is a short term savings goal. Things like down payments, weddings, vacations, etc fall into this category of savings goals.

Long term

Retirement will be the biggest long term savings goal to keep in mind, but can also be things like “forever home” or children’s college funds.

How to save for each

At a high level, the conversation is about risk/reward tolerance for the saver. With investment vehicles like savings accounts and money market accounts being on the low risk / low reward side of things that generally lose to inflation, they are not good candidates for long term savings goals. The less your investment has in returns, the longer your goal becomes. This is discussed in more detail in the asset allocation. Investing in low risk/low return investment vehicles like CDs/HYSA/Money Market/Bonds is about combating inflation and downside protection, not the yields themselves.

At a high level: short term goals should be about preservation of capital, and long term goals should be about optimizing gains.

That being said, it’s still a personal decision. I advocate for a mixed strategy for short term goals, but only if you’re flexible in your timeline. For instance, we are saving for a home down payment right now.

Let’s say I am targeting 20% down and have $50,000. I would like to buy a home in 5 years and save $15,000/yr (total principal of $125,000). We’re ok with a home in the $500,000 range, but prefer a home in the $600,000 range.

At the beginning, I could invest $50,000 in the market, and save the $15,000/yr in cash. This would de-risk my down payment progressively. By year 5, we would have $75,000 in cash and (hopefully) more than $50,000 in equities. You are statistically likely to have more than $50,000 in equities, but you do run the risk of losing a large portion of it. The question is “how do you handle losing half of your principal?” If you’re ok pushing off your home purchase until the market recovers or you save more cash, then great. If you lower your target purchase price, that’s great too.

In the scenario above, we’ve set ourselves up to be comfortable losing 50% of our principal ($75,000 cash + 50% * $50,000 = $100,000 or $500,000 in home purchasing power). If the market returns the 10% YoY it historically has, we have over $80,500 in equities. This allows us to purchase a home of up to $777,500 (($80,500 equities + $75,000 cash) * 5).

If you are less flexible in either timeline (i.e. children are becoming school aged, lease is coming due, etc), then a market crash of 50% may be too costly by forcing you to make a decision that you’re not comfortable with. In this case, there is nothing wrong with being less optimal. There is a value in safety! In the above scenario, holding the principal in a high yield savings account at today’s ~1.15% APR still yields you ~$129,700 or $648,500 in purchasing power. While it is a substantial difference, it still has you comfortably above your desired purchase price.

tl;dr: Define your risk tolerance and the parameters of your savings goal. Acknowledge that this isn’t an all or nothing problem. Make a plan and stick to it.