Long-term savings (3-5+ years)
Recommended choice: Target date fund (starts at 90-10 split between stocks and bonds, then shifts gradually to bonds as you age.)
For money you don’t intend to spend within the next 3-5+ years, the simplest and safest option is to put everything in a Vanguard Target Retirement fund. Choose the fund that most closely matches the year that you will turn 75 years old**. I was born in 1983, so for me, that’s the 2060 fund. Each Target Retirement fund will automatically allocate you between large, medium, and small stocks, as well as US vs international. It will also shift you more and more into stable bonds and away from volatile–but high growth– stocks as you get closer to retirement/old age.
It’s the ‘set it and forget it’ option for any long-term goal that automatically rebalances you and keeps you diversified across asset types and regions of the world.
Long-term choice for those at Fidelity
Fidelity also has great Target Date index funds. Go with their Fidelity Freedom Index fund that matches when you turn 75. Make sure to select the ‘Index’ version and not the (non-index) Fidelity Freedom fund version since the latter has a higher expense ratio. If you have a 401k or 403b plan through Fidelity you may only be able to choose the more-expensive Fidelity Freedom (non-index) version, which is fine.
Alternative choice for the more hands-on & risk-tolerant investor: 100% in stocks
If you would rather take a little more risk and don’t want your investments to gradually shift more into bonds, i.e.: you’re willing to let these savings ride the stock market wave indefinitely, invest either 100% in US stocks via Vanguard Total Stock market fund, or if you’d feel better diversifying beyond the US, do a 70-30 split between that US fund (70%) and 30% in the Vanguard Total International stock fund. You should rebalance once per year if you split your money between the US + International stock funds, but you’re no worse off than only choosing the US fund if you don’t…
While I recommend the Target Date fund for others– including my wife!– for its simplicity and zero maintenance effort, I personally go with all stocks in my accounts because I’m 1) keeping separate money in a bond fund for emergencies, plus I always have cash piling up because I save over 50% of my income, 2) my wife & I have steady incomes, so I’m not worried about needing my stock money anytime soon, and 3) I’m good about occasionally checking my investments and rebalancing to keep my desired ratios roughly constant over time.
Short-term savings (0 – 3 or 5 years)
Recommended choice: For ‘short-term’ savings, money you need between 1 year from now up to 3-5 years, put everything in the Vanguard Short-Term Treasury Bond index fund (ticker: VSBSX).* (ETF version ticker: VGSH) It’s very stable (expect a max swing of 5-10% up or down), but will generally return higher interest for you than a savings account (the 30 day SEC yield number is probably your best bet to estimate your expected annual yield, but this will change as interest rates change over time.)
A bond fund is more liquid than a CD or treasury bonds because you can cash it in whenever you like, just like a stock or mutual fund. This makes it an ideal investment choice for your ‘emergency fund’ as well.
Vanguard inflation-protected short-term option
Vanguard also has a short-term inflation-protected bond fund (ticker: VTAPX), also available as an ETF (Ticker: VTIP), if you’re worried about inflation.
If you’re at Fidelity, I recommend their Fidelity Short-Term Treasury Bond index fund (Ticker: FUMBX.)
Fidelity inflation-protected option
Fidelity also offers an inflation-protected index bond fund if you’re concerned about inflation (ticker: FIPDX), BUT it’s a long-term fund, which means you’re more exposed to interest rate risk if interest rates go up. Thus, I’d recommend the short-term inflation-protected VTIP ETF at Vanguard instead.
For any savings that you need in the next year like your upcoming vacation, a new phone/gadget, or annual insurance payments, use a high-interest, no-fee online savings account like Capital One 360 or Ally Bank. I like to have multiple sub-savings accounts for each of these types of spending as part of my budgeting system.
Conclusions
Whether you’re investing long-term for retirement in a 401k or Roth IRA (long-term), or for early retirement in a taxable account (long-term), or saving for something in the next couple of years like a wedding or house downpayment (short-term), these two funds have you completely covered.
Keeping your investment portfolio simple makes it much easier to manage and to achieve your goals. Don’t be fooled by investment professionals/brokers or ‘advisors’ who make a living selling you different investments to generate commissions or kickbacks (“revenue sharing”) for themselves.
For 98% of people, these two investments will be all you need for your entire life.
Addendum: How to rebalance your investment portfolio
If you must complicate your life and go with a US + International stock index fund instead of the recommend Target date fund, rebalancing is actually pretty simple with a very tiny amount of math or this spreadsheet.
Let’s say at the end of the year you have $60,000 in your US stock fund and $30,000 in your International one, and your desired split is 70% US and 30% International. First, compute what you should have in your US fund by adding together all your investments across all your long-term accounts: $60 K + $30 K = $90 K.
Next, multiply your total long-term balance by the ratio you want to have in your US fund: $90,000 * 0.70 = $63,000.
Lastly, subtract from that target number the amount you currently have in that US fund: $63,000 target – $60,000 right now = +$3,000 that you need to move from your International fund into your US fund. Once you move that $3,000 from your International fund you’ll have the correct $63,000 (70%) in the US fund and the correct $27,000 (30% of $90,000) in your International fund.
More than two funds
If you have more than two funds to rebalance this gets more complicated, but the idea is exactly the same. Just repeat for each fund. Use the spreadsheet.
* If your accountant says you should save on taxes, exchange the Vanguard Short-term Bond fund for one of Vanguard’s Municipal/Tax-exempt bond funds, such as the Vanguard Short-Term Tax Exempt fund, for your taxable account(s.) Don’t put a tax-exempt/muni fund in a tax-advantaged account such as a 401k/IRA since the interest there isn’t taxed anyway!
** Yes, choose the fund date that matches your 75th birthday even if you’re going to retire much earlier than that, which I hope you do! Choosing the target date this way ensures that your money stays allocated to a large enough proportion of stocks as you age to get you the growth you need to retire comfortably. I find Vanguard’s default option to be too conservative for myself and my clients: I think that it rushes people into bonds too quickly. You can always read up on how the asset mix changes between stocks & bonds/cash in Vanguard’s Target fund to select what you’re most comfortable with.
