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Consider your risk tolerance and time horizon when choosing how to invest your money.

Close up of savings jars with money.

When it comes to money for short-term goals, finance experts say people should focus on saving rather than investing.(GETTY IMAGES)

You will find plenty of advice about which stocks are hot and how to invest money in the stock market. However, many of these conversations leave out an important consideration: Why are you investing?

“We really think if you take a goals-based investment approach, that is best,” says D. Keith Lockyer, investment market manager with the financial firm PNC Wealth Management. Cash for next year’s vacation needs to be treated differently than cash for a retirement 20 years down the road.

The idea of risk versus reward is central to smart investing. You don’t want to risk, and lose, your money right before you need it. However, keeping money in safe investments, like bonds, could result in few gains and mean you won’t have enough for your long-term goal.

Here’s a look at savvy short- and long-term investing strategies that will help you balance risk and reward depending on when you’ll need your cash.

Saving for the Short Term

When it comes to money for short-term goals, finance experts say people should focus on saving rather than investing. Money needed in fewer than three years needs to be protected from market volatility.

“Short-term [investing] is where people make mistakes,” says Oliver Lee, owner of The Strategic Planning Group in Lake Orion, Michigan. “They see the bright light that says 6 percent and jump in.” However, those types of returns usually require people to take risks they shouldn’t with money that will be needed shortly.

For short-term goals, try one of the following short-term investments:

  • High yield savings accounts.
  • CD ladders and money market accounts.
  • Short-term bond funds.
  • Fixed income funds.
  • Structured notes.

High Yield Savings Accounts

People should forget about investing money needed in less than a year. Instead, find a high yield savings account to keep money safe and instantly available.Online banks such as Marcus by Goldman Sachs and Barclays are offering APYs as high as 2% on their high yield savings accounts. While that isn’t as much as what can be earned in investments, money in a savings account is insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 and is therefore safe from any loss.

You may be able to earn slightly more by placing money in a certificate of deposit (CD) rather than a savings account. However, the best rates are only available if you agree to tie up your money for at least a year or more. To keep cash liquid, some people set up CD ladders with varying maturity dates. This approach ensures at least part of the savings will be available at any given time.

Money market accounts are another short-term investment option. “While the Fed is currently lowering rates there are many money market funds that provide a reasonable yield for short-term cash,” Lockyer says. They can offer comparable interest to some CDs and come with fewer restrictions. However, you may be allowed only a limited number of withdrawals from the account each month.

Short-Term Bond Funds

Once a person’s time horizon moves past 18 months, it begins to make sense to place money in relatively stable short-term investments. Short-term bond funds are one way to increase returns with relatively little risk.

Still, the gains on these funds are minimal compared to other investments. Ten-year annualized returns for many bond funds hover around 2% to 4%.

Fixed Income Funds

Similarly, fixed income funds offer a relatively stable way to get a return greater than that offered through savings or money market accounts. Many of these funds include bonds, but they may also include other securities. Fixed income funds don’t offer much in the way of gains, but they are designed to minimize risk and limit losses in a down market so they can make good short-term investments.

Michael Windle, a retirement income certified professional and owner of C. Curtis Financial in Plymouth, Michigan, says people sometimes make a mistake by thinking they need to save up thousands of dollars before they can invest in fixed income or other market funds. “Instead of parking money in a savings account, just put it in [investments],” he says. Doing so can help improve overall returns.

Structured Note

Windle likes this short-term investment option for those who may have a few years before they need money. “They follow a bucket of stocks and indexes,” he says.

Structured notes offer a diversified investment that can minimize the chance of loss while offering a customized return. “They pay a higher interest and take some of the downside risk,” Windle says. They can pay as much as 6 percent in interest, but be prepared to hold the note to maturity since they can be difficult to sell after issuance. Since their terms can be complex, structured notes may be best purchased under the guidance of a financial advisor.

Investing for the Long Term

For money that isn’t needed for at least three years, look at putting at least a portion in stock market equities. Since most bear markets last from nine to 16 months, someone investing with a five-year time horizon can afford to risk a down market. Their investments will likely rebound before the cash is needed. However, to be safe, people should begin moving money to bond and fixed income funds as it gets closer to when it will be used for its intended purpose.

Mark Charnet, the founder and CEO of American Prosperity Group, a financial firm based in Pompton Plains, New Jersey, says workers need to be cognizant of how long they have to make up losses. They also need to move their money to more conservative, less risky investments as they get closer to retirement.

As to where to park money for long-term needs, finance professionals recommend the following long-term investments:

  • 401(k)s and IRAs.
  • 529 plans.
  • Index funds and ETFs.

401(k)s and IRAs

Money for retirement should go into one of these tax-favored accounts whenever possible. Employer sponsored 401(k) plans may come with a company match for worker contributions. Plus, retirement accounts, including IRAs, offer either an immediate tax deduction or future tax free withdrawals, depending on whether a traditional or Roth account is used.

“To determine which type of retirement plan would be the best choice, you must analyze your current tax situation, level of contributions until retirement and your forecasted retirement income from all sources,” Charnet says. “That will help you decide if the present tax deduction is worth paying taxes on your future income for the rest of your life.”

Most plans offer a number of fund options, and target date funds may be the best choice for those who don’t want to bother with monitoring and reallocating investments as they age. Target date funds are set up based upon when a person expects to retire. As it gets closer to that year, the fund automatically transitions money to bonds and other less volatile investment options.

529 Plans

For college savings, 529 plans are a good long-term investment option. These plans offer tax exempt withdrawals for qualified education expenses. Some states also let residents deduct contributions from their state income taxes. Like the retirement plans above, 529 plans often include target-date funds that can be selected based upon when a child will reach college age.

“You can get more aggressive to start and then be more conservative when you are closer to your goal,” Windle says. Like other equity investments, 529 plans can lose money in a down market and transitioning to bond or stable funds can minimize the chance of a loss for an older child.

Index Funds and ETFs

When it comes to money for other long-term goals, such as buying a house or starting a business, opening an investment account through a brokerage is the best way to put money aside. Within these accounts, index funds and exchange traded funds (ETFs) offer low fees and the best value.

Index funds are intended to keep pace with the overall market, but ETFs can be more variable. Both contain a collection of securities that can help spread risk, but investors should do plenty of research before sinking money into a particular fund.

Actively managed funds are another option for long-term investments. While they can come with higher fees, they also may outperform index funds and some ETFs. However, the increased gains also means they are more susceptible to market volatility.

One of the mistakes people make with these funds is losing sight of why they are investing the money, Lockyer says. “They focus on beating benchmarks instead of the goal,” he explains. Like every other long-term investment, the promise of financial reward must be balanced with the risk of losing money before it is needed. Check with a financial planner to learn more about which funds are right for your goals and risk tolerance.