Investors often focus their resources on retirement and education goals. That’s appropriate in most cases; nearly everyone has those same investing goals. There are additional goals for which investors may wish to accumulate funds, such as future car replacement, the purchase of a second or vacation home, or the purchase of a boat or an airplane.
The mechanics of investing for these goals is not unlike education or retirement goals, other than the limited account options. There are some additional factors investors should consider in planning for these goals.
Risk Versus Reward
Retirement planning and education planning are long-term goals, with the rare exception of starting late. Retirement is always a long-term goal from a planning perspective; even at the time of retirement, you’re investing for 30 or more years out. Investing-wise, that’s long term.
Other accumulation goals often fall into a short-term or mid-term investment horizon. There’s no universal rule for what constitutes different investment horizons, but goals within five years can be considered short-term goals and those falling between five and 10 years out mid-term goals.
The shorter time frame restricts the investor’s ability to safely pursue higher returns; there is no reasonable amount of investment risk to assume for short-term goals. Short-term goals aren’t goals we should invest for; they’re goals we should save for.
The difference is that, with investments, we expect the investments to provide a portion of the funding; we expect the investments, on average, to grow at a rate greater than the rate of inflation, increasing our future purchasing power.
With short-term investing goals, we get no such advantage. We don’t expect the investment performance to contribute to the need. In the short term, we avoid volatile investments because there’s too much risk.
The risk of potentially higher return from a volatile investment isn’t worth the potential reward in the short term. We need time for that risk to make sense, and in the short term we don’t have that time.
If we need to save, for example, $20,000 toward a car in five years, we really need to save $4,000 per year to get there. Any return we get may at best cancel out inflation. If we expect inflation, we need to increase our savings rate even higher; we don’t have time to invest to outperform inflation.
We see this clearly with some accumulation funds where the goal is within the next year. A vacation fund or holiday fund can be good examples. We save for these goals, using nonvolatile investments. It is more important that the funds not be subject to volatility: We need them when we need them — and that’s soon.
Taxation of Investment Accounts
Many education and retirement funding options offer tax advantages. There are not such attractive options for other accumulation goals. Investors need to consider the tax consequences of different savings and investing options.
The good news for savings options is that they’re unlikely to cause a big tax problem. Not earning much means there won’t be much to tax.
When considering investment options for longer-term accumulation goals, taxes can be a significant issue. Investors need to consider ongoing taxation that they may incur from investments they hold, and also need to consider taxation upon liquidation of appreciated assets when the time comes.
It’s not always best to focus on paying the least in taxes. The most effective strategy is the one that allows the investor to net the most after taxes. A higher return may yield more to the investor after taxes than might a lower-returning but more tax-favored investment. In the end, it’s what you keep that matters.
Commingling Investment Funds
Some investors commingle funds for multiple investment goals. The intent is to build an overall investment portfolio that is slightly more aggressive than they might have if each were structured individually.
For example, an investor might be seeking to accumulate funds to replace a car in five years, purchase an airplane or boat in seven years, and purchase a vacation home in 12 years.
Commingling the funds into a single account may lead to an investor selecting an overall portfolio that is more aggressive than the combination of individual portfolios would be.
They do this because the combined conservative elements of the individual portfolios would be more than sufficient for the nearest goal, providing the appearance of being able to reduce the conservative portion of the overall allocation.
There is undoubtedly increased risk with this approach; investors need to consider their own objectives and risk tolerance before making a decision to increase portfolio level risk.
Overfunding Investment Goals
Some people have the enviable problem of having more resources than goals; leftover money accumulates without a specific need or purpose to tie it to. Others of us never would run into such a problem because we would always find goals for the money.
Investors faced with the excess funds problem should consider these to be long-term investment funds, presuming all other goals are sufficiently funded. Naturally, the funds are not excess unless all other goals are sufficiently funded.
An additional consideration, if goals are overfunded and there is no apparent need for the money, is to consider using a Roth IRA. The Roth provides tax advantages to the investor, and if the funds remain unused, to the investor’s heirs. There are income limits to consider; not everyone is eligible to contribute to a Roth IRA.
Others may consider a backdoor Roth, although there is pending legislation that could eliminate this option going forward. If available, a Roth IRA is often an ideal option for funds that the investor will most likely never spend.
The Bottom Line on Investing Goals
A lot of attention is paid to funding the traditional accumulation goals of education and retirement. These have their own account types and specific tax considerations. Time frame is also pretty much dictated to the investor, within reason.
Other accumulation goals run the risk of neglect. When neglected, the goals may remain unfunded, or worse, contribute unnecessarily to the tax burden or bring unnecessary risk into the picture.
By considering the time horizons, and differentiating between savings and investing goals, the investor is better positioned to manage both risk and taxes. This leverages what the investor gets to keep, and it is our net returns that allow us to accomplish our goals.