When Low Interest Rates Are OK

“A singular mission to outperform can actually lead to underperformance.” A Wealth of Common Sense blog by Ben Carlson

Do you fret because you’re saving for a downpayment on a house you plan to buy in a few years and you think you should be “doing something” with it? Such as…investing in a bond fund or even an equity mutual fund? If so, your worry reflects a common misconception of the purpose of investing.

In our current low interest-rate environment, we hear many requests for creative ways to earn more on money that is just “sitting there”. But when it comes to cash you’re going to need in the short term (a.k.a. the next 5 years), the answer isn’t to “do something!” but another question: “What is your plan?”

While it appears to be quite reasonable for a client to ask how she could do a little better on the money in her savings account, expecting a growth investment to be wrapped in a money-back guarantee is illogical. Let’s examine why…

An investment is the purchase of property to create future wealth. Investing is a long-term process, a time period for you to let your property grow in value and exhibit patience. Growing a successful business like Apple or Toyota is not a short-term project. You must be willing to be patient if you hope to enjoy your share of the profits.

Buying property in hopes of reaping short-term growth and/or income isn’t “investing” at all. It’s speculating, which is a high-brow form of gambling. You should never expect an investment to grow much in the short term and you should not be surprised if it declines in value during that time frame. Short-term speculating is totally unpredictable, just like betting before looking at your cards in a poker hand.

So what should you do with the money you’ll need for short-term goals? Put it where you can get to it when you need it. This is the time to use high-interest savings, CD’s and bonds timed to mature at the date of need.

In the short term, income is not your priority. Having a stash of ready cash is the purpose of an emergency fund because, by definition, emergencies don’t happen on a timetable. The fact that you may earn a tiny bit of interest while your money waits for the next emergency is nice, but not something that should really matter much in the overall scheme of your plan.

Same with saving for a specific need: you don’t want to speculate with the funds for your practice buy-in or your daughter’s wedding in a couple of years. The chance that you may make a killing is far outweighed by the risk that you will need to move the reception to Cracker Barrel when that bond fund takes a nosedive.

What about seniors on a fixed income? Unfortunately, low returns are especially painful when you are on a fixed budget and can’t go back to work to pay your bills. Because most retirees are facing multiple-decade retirements, low-interest CD’s and bonds are appropriate only for a 5-year window, not 20 or 30 years. The ownership of CD’s and bonds should be determined by your financial plan, not by fear and wild guesses.

The best way to determine how much of your savings to allocate between short-term needs and long-term growth is with a financial plan. This can be a simple DIY plan (I recommend the book The One Page Financial Plan) to ongoing comprehensive planning with a fee-only CFP®.

Never expect a savings account to act like an investment portfolio. Remember:

  • Your short-term savings priorities are 1) liquidity and 2) safety.
  • Your long-term savings priorities are 1) growth and 2) income.


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