Investing with a medium-term timeline

Investing with a medium-term timeline poses its specific challenges. An investment plan looks into the future and includes, next to retirement, things like a new car or home purchase in a few years, education expenses for children, just to name a few.

Each of these goals require money in different time frames, and the money should be invested accordingly. Often investors will divide their investments in buckets according to the goals and timelines, and managing each with a specific strategy.

Overview
One could distinguish the following kind of goals with a medium term timeline:
 * Saving for regular/anticipated purchases that cannot easily be funded from cash flow: such as expenses for household appliances, new car, marriage, children.
 * Medium-term investing for specific projects that are some years away: like a down payment for a house or setting up a small business.
 * Saving for education: this is very specific; please refer to the pages in the education savings category on this wiki.

An investor would like to invest money for goals with a medium-term timeline in a vehicle with better return than cash to give this money a chance to grow. The guidance of the Bogleheads® investing start-up kit and the Bogleheads® investment philosophy certainly applies for investing with a medium-term timeline. Special care has to be taken to correctly understand the need, willingness and ability to take risk on medium term and to take that into account in the asset allocation (AA) for the medium-term investing.

Investment authorities commonly advise investors with medium-term goals coming due within five years or less to restrict investments to short-term instruments such as bank CDs, money market funds, and short-term treasury securities that all mature by the time the funds are needed. Longer term goals can include asset classes that fluctuate in price.

An emergency fund is in a very specific bucket. It is a cash reserve required to meet unanticipated needs for cash, such as medical bills or job loss. The goal of the emergency fund is to provide a cushion of liquidity in the event of unexpected expenses or of a loss of regular income due to unemployment.

Elements to take into account when determining how to invest for medium-term
The characteristics of the project for which one is saving poses constraints on the investment. What is the need, willingness and ability to take risk on these medium-term timeline.
 * Is capital preservation mandatory? Or can the capital be put at risk to strive for higher return?
 * What flexibility is needed? How firm is the timetable of the project? Is it possible that the project needs to be initiated earlier than initially planned? Can the project be delayed if the investment does not have the necessary value at the target date, either due to lower return or loss of value? Can the project be put off until the investment recovers?
 * What is the savings rate, could one make up the shortfall before the target date if the value of the investment does not correspond to expectations?
 * What is your general approach to investing, what is your current Asset Allocation?
 * Particular tax considerations can also limit (or extend) the choices for the investment.

Saving/investing allocation options
One can distinguish classes of investment instruments suitable for the medium-term timeline. One should control the duration of the instruments to be in line with the due dates of the projects and ensure the quality is very high to avoid loss of principal.


 * Cash like: Very liquid and super easy to access, guarantee on the capital (if federally insured), lower return. Examples: Checking account, money market fund, (High Yield) (insured) savings account.


 * Reward checking account[RCA] : somewhat higher return, if one is willing to put in the effort to set-up and maintain to get the higher APR.


 * Fixed income instruments: Different kinds of bonds:
 * CD and similar: can be federally insured, will have early withdrawal penalty if not kept to term. Buy multiple sizes to avoid breaking the full CD and pay EWP on them.
 * US savings bonds: 1-year lockout, annual purchase limit.
 * Short term United States Treasury security
 * Tax-Exempt Municipal bonds Funds
 * I savings bonds

With respect to the timeline, it is advised to convert as the due date nears; from equity to bonds to safe fixed income instruments and finally cash. One can dollar cost average gradually to achieve this.
 * Funds and ETFs: Longer timelines can be satisfied with safe (quality short-term) bond funds/ETFs, or even safe equity funds/ETFs if one can bear the risk.

The options mentioned in the multi-tiered emergency fund can also be useful for medium-term investing.

Various forms of credit (including HELOCs ) could be used for medium-term goals, however is this in line with the bogleheads way?

General practice: use taxable accounts
Saving for short and medium term goals should be done in a taxable account (checking, savings, CDs,...). because taxable accounts do not have an annual contribution limits; they are refillable: take some money, put some money back, not a problem.

It is not recommended to save for known short or medium term needs/goals in a tax-advantaged account. Because such TA accounts have annual contribution limits. While it is possible to withdraw money under special considerations, they are not refillable, you can't put the money back after an early withdrawal. Your retirement growth potential is permanently harmed.

In exceptional cases: use a tax advantaged account
On the other hand, it might be advantageous and possible to utilize non-used tax-advantaged space with extra contribution that have a medium-term timeline. This takes advantage of valuable Roth IRA contribution space that would be lost forever if you do not contribute. Compound interest requires time and money to work. Tax-advantaged space is better than taxable space. More tax-advantaged space is better than less, so use all you can every year. The advantageous is more likely if the mid-term goal is not certain. At the time of the purchase one would then retrieve the extra contributions but not the earnings from the account. (Please also read the description in the wiki page on Roth IRA as an emergency fund).

If you have a sizable taxable account, it is possible to place a cash needs requirement, such as a home down payment, in a tax-advantaged account and improve the overall tax efficiency of an investment portfolio.

Boglehead forum discussions

 * Asset Allocation for a young investor seeking to make a down payment in 3-5 years
 * Aligning Cash and Emergency Fund with years of Living Expenses
 * Where to invest money in taxable account to use in 5 years
 * Buying a house in 2-4 years; what do I do with my mutual funds?
 * Bond Fund for Extra Cash / Emergency Fund?
 * Taxable account with 6-10 year horizon