How to Invest for Short and Medium-Term Goals
Key Takeaways
Unlike Long Term Investing your risks in the short term are higher due to the shorter time horizon and you need to pay extra attention to ETFs you select
A 5 or 8 year time period is relatively short and a Medium-Term Investment Portfolio should be relatively simple with up to 3 ETFs
After assessing your Risk profile you can construct a portfolio quite easily and reduce costs/fees. What most people don’t realize is that this can be done without much financial knowledge
Select at least one Bond and one Equity ETF and rebalance quarterly or semi-annually
Note for European Investors: This guide is currently presented from US Investors perspective but the same logic applies for European and UK Investors (see my relevant guides to pick the right ETFs)
Short and Medium Term Personal Goals
Reach your goals and protect your capital
There’s plenty of advice when it comes to investing for retirement.
But what about your medium-term goals? What if you want to buy a house in five years? Or what if your child is heading to college in eight years?
Below are some examples of Medium Term Personal Finance Investment Goals:
- House downpayment
- Wedding
- Gap Year Travel
- Children Education
This article will help you construct an easy and cost-efficient ETF Portfolio to reach your goals and protect your capital
Two Building Blocks Core Portfolio
Key Ingredients for Financial Success
In order to construct a Medium Term Portfolio you need at least each of the following:
- One US Market Equity ETF (#1)
- One US Aggregate Bond ETFs (#2) + Corporate Bond ETF (optional)
Example of Asset Allocation for Medium Term Investment Strategy
The above allocation is an illustrative example of 5-Year portfolio for someone with some confirmed appetite for risk:
- 30% is Allocated to Equity ETFs
- 70% to Fixed Income ETFs
- An optional Corporate Bond ETF is added as part of the Fixed Income allocation to increase the Returns of the Fixed Income Allocation (you can keep the 70% in Blend Bonds)
Before You Start
UNDERSTAND YOUR NEEDS
How much money should I keep in Bonds?
- Remember, knowing yourself and your goals matters most – you should always align your Portfolio with your objectives and that’s why this Portfolio should be individual and tailored to your needs and not benchmarked against other people you know
- Take a questionnaire first to understand what Stocks/Bond allocation you need related to this specific goal
- The questionnaire will take some key inputs like how soon is your deadline or how comfortable you are with the ups and down of the market (i.e. would you be comfortable seeing 30% of the money you’re saving up for a house disappear during a market crash?)
- Use the results to buy the recommended ETFs below in the right proportions
- Understand that rebalancing of your portfolio is the key to being successful with any index investment strategies
Allocation to Bonds is key for Medium Term Goals
Historical Probability of experiencing negative returns for a 60% Stocks 40% Bond Portfolio
Simulation of over 500 Portfolios from 1976 to 2020 of a 60% Stocks / 40% Bonds Allocation - Sudden losses can stir your emotional impulse to withdraw or suddenly change tack – no-one likes to see their portfolio go down in value – but staying put and resisting the temptation to tinker can pay off in the end. Chances of seeing a portfolio with ANY losses are drastically reduced if you hold a portfolio for over 4 years
- Starting Investing Early for your Goal helps – remember, the longer the time horizon the lower the chances of losses in a stock market that goes up in the long term. Medium term investing can be tricky because time is just not sufficient enough to eliminate any chances by historical standards of losses
- But with the right asset allocation you can obtain the same no loss likelihood by increasing the allocation to Bonds e.g. historically you were not experiencing any losses for a 70% Bonds 30% Stocks Portfolio over 5 Years
- You can gradually increase the allocation to Equities as your Investment Horizon gets longer above 5 Years
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Beginners often ask us:
- How do I reach my goals – What investments do I need to take into consideration when e.g. Taking a Sabbatical, buying a House or saving for Early Retirement?
- When should I invest – I fear that investing a lump sum in this market may have a negative impact on my returns. How can timing of buying ETFs affect my performance?
Advanced investors may avoid costly mistakes:
- Challenge my Portfolio – Here is my portfolio – what am I missing? What could derail my strategy? What can I do to protect my portfolio from shocks?
- Help me quickly understand – What makes Inflation Linked Bonds outperform? Bond Ladder or Bond ETFs? Why do some investors add Small Cap Value stocks to their portfolios? How can I exclude Tobacco companies from my portfolio? Are the synthetic ETFs I screened safe? What is Factor Investing?
By signing up for a financial coaching session you support our website and our investment research. Here are other ways to help.
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Book a coaching session
Beginners often ask us:
- How do I reach my goals – What investments do I need to take into consideration when e.g. Taking a Sabbatical, buying a House or saving for Early Retirement?
- When should I invest – I fear that investing a lump sum in this market may have a negative impact on my returns. How can timing of buying ETFs affect my performance?
Advanced investors may avoid costly mistakes:
- Challenge my Portfolio – Here is my portfolio – what am I missing? What could derail my strategy? What can I do to protect my portfolio from shocks?
- Help me quickly understand – What makes Inflation Linked Bonds outperform? Bond Ladder or Bond ETFs? Why do some investors add Small Cap Value stocks to their portfolios? How can I exclude Tobacco companies from my portfolio? Are the synthetic ETFs I screened safe? What is Factor Investing?
By signing up for a financial coaching session you support our website and our investment research. Here are other ways to help.
#1 Choosing an Equity ETF
ETF Benchmark Risk & Annual Returns (2000-2020)
These are Total returns including dividends from different US Asset Classes - US Equities generated about 7% per year including Mid and Small Caps
While for Long Term Investment Horizon International Exposure is necessary a 5-year Portfolio can be kept relatively simple with US Equities
Do you need International Exposure?
- US Equities represent c. 55% World Stock Capitalization and should be the cornerstone of the risky part of a portfolio
- S&P 500 companies are already diversified from a Revenue perspective – over 40% of Sales comes from Global Markets
- US companies deliver high returns with lower risks (in terms of volatility but also operational risks like governance issues / fraud etc.)
- US Dollar will remain the reserve currency at least in the short/medium term and foreign companies will be attracted in listing their Stocks on the largest Stock Exchange
Equity Market capitalization of Developed and Emerging countries
For a 5 Year Time Horizon I think that US Equities provide enough diversificaton without making the portfolio rebalancing too complex. You may further refine the Equity allocation by including some of the additional asset classes but US Large Caps already fulfill a lot of requirements for a short/medium term Investment Portfolio
#2 Choosing a Bond ETF
Keep it simple
I like to keep investing simple. Bonds can be a bit intimidating due to their perceived complexity vs. Equities. But you probably only need one ETF to achieve your goals
- Bonds can help you re-balance when you need it the most and buy cheap Equities during a crisis
- They also tend to increase in price during volatile periods (AGG ETF performance during major downturns) with Treasuries being the most sensitive to downturns
The Easy Way
BUY AN AGGREGATE BOND ETF
One ETF solution – Blend Bond ETF
This is the easiest way of getting exposure to Bonds is through a high quality blend bond ETFS. This ETF is a broad market Bond ETF:
I suggest either of:
- iShares Core US Aggregate Bond ETF (AGG) for Bonds (expense ratio of 0.04%)
- Vanguard Total Bond Market ETF (BND) with slightly lower fee (expense ratio of 0.035%)
To understand the difference you can also have a quick comparison of main Aggregate Bond funds here.
Optional - Add some Yield
High Quality Corporate Bonds
- Corporate Bonds provide you with higher income than Aggregate ETFs because they also have some default risk (albeit relatively low)
- However, Corporates have a positive correlation with Equities hence it won’t protect you much during a downturn (see here how they reacted during COVID) so allocation should be quite modest
Current Yields on Bond ETFs (vs. Inflation)
As you can see from the chart below an Aggregate Bond ETF like BND will currently yield c. 1.5%
Read more about the Top Corporate Bond ETFs that FED is buying now or my comprehensive guide to Bond ETFs
If you have a Time Horizon above 5 years you could add a small part of Portfolio Bond allocation to Pure Corporate Bond ETFs like VCIT or LQD that will increase your returns - click on the image above to review the Corporate Bond ETFs
#3 Optional - Additional ETFs
If you want to keep it simple you should stick to the above 2 ETFs.
However, you may be tempted to replace part of your Equity and Bond allocation with other asset classes. Here are a few observations.
Asset Class performance tends to move a lot
- Below is the matrix ranking the asset classes by their returns each year and overall
- In the below Matrix the “Bonds” box corresponds to the AGG ETF from the Core Portfolio
- The S&P 500 can be a proxy for the Equity part of the Portfolio
Click here to read more about some of the conclusions
A 10-Year Perspective
Adding other asset classes can singnificantly change the risk/return profile of your portfolio - be sure you're comfortable given your goals and time horizon
Alternatives for the Equity (Risky) Part of your 5 Year Investment Plan Portfolio
Some investors replace part of the US Equity ETF Allocation of the above Core Portfolio with some the below:
- Nasdaq ETFs
- Dividend Stock ETFs
- Developed Markets ex-US ETFs
- Emerging Markets
- Real Estate ETFs
FROM OUR TEAM
This website was created to provide you with all necessary resources to invest without incurring any additional costs.
Servers, data, and software are some of our costs, just to name a few. Most importantly, our time is the main resource to create great content. If you find that our guides helped you on the path to financial success, you may give us a hand by buying a coffee.
By buying us a coffee you support our website and our investment research. Here are other ways to help.
FROM OUR TEAM
This website was created to provide you with all necessary resources to invest without incurring any additional costs.
Servers, data, and software are some of our costs, just to name a few. Most importantly, our time is the main resource to create great content. If you find that our guides helped you on the path to financial success, you may give us a hand by buying a coffee.
By buying us a coffee you support our website and our investment research. Here are other ways to help.
BONUS - What can I expect?
What could have happened if I held longer or needed to sell earlier?
Holding a different mix of Stocks / Bonds wouldn’t have made a material difference to returns because Bonds had a few exceptional decades but the ranges of returns would have been materially reduced by adding Bonds (hence locking better returns for lower risk).
A 30% Stocks 70% Bonds portfolio:
- Would have generated an average annual return of 9% since 1976
- Would have experienced a worst scenario of positive 1% annual return if held for 5 Years
- The same portfolio could have had an annual loss of 1% in the worst case if held for 3 years instead of 5 Years
- If the time horizon was lengthened to 10 Years the minimal worst case annual return would have been a positive 3%
- While we focused here on limiting downside risk, the below graph shows that there were some exceptional double digit annual returns in some scenarios
Historical annual returns and annual return ranges based on holding period (1976-2020)
The graph above incorporates over 1000 SCENARIOS (!) with ANY POSSIBLE entry point at the end of each month with different time horizons making it INDEPENDENT FROM THE STARTING POINT - the key takeaway is that no matter the market environment you need to hold your portfolio above 3 years to significantly reduce downside risks
What can I currently expect?
Current investment environment is particularly difficult. Below are 3 scenarios:
- Taking Historical Averages for both Stocks and Bonds (this is a benchmark since bonds won’t have the same returns). A 100,000 Investment returned historically on average 141,000 over 5 Years
- Taking 11.3% Annual Returns for S&P 500 and current Bond Yields – in this scenario the 100,000 Investment would return 125,600 in 5 Years
- Taking last 2 decades of S&P 500 Returns and current Bond Yields – in this scenario the 100,000 Investment would return 116,400 in 5 Years
30% Stocks / 70% Bonds Portfolio Balance over time
Bond yields are currently so low that historical returns are inadequate and would overestimate the portfolio returns hence current Yield to Maturity is used as proxy - the most conservative scenario is in Orange based on historical averages. These returns could be enhanced if investing a small portion in Corporate Bond ETFs (here for simplicity only an Aggregate Fund is modelled)
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