Let’s say you make a major purchase in the future. Maybe you’re buying a house, a car, paying for college, or taking the vacation of a lifetime.
If you’re not planning to buy in the next five years, money expert Clark Howard will give you the buffer to invest your money. The longer you wait, the more likely you are to see a positive return from the overall stock market.
But what if your big purchase is approaching faster? What do you do then?
The US government cites the Consumer Price Index (CPI) (from the Bureau of Labor Statistics) for inflation data. By January 2022, this index had risen 7.5% in the previous 12 months, the fastest since February 1982.
At the same time, the average savings account at a US bank earns 0.06% interest.
Let’s say you’ve chosen one of the best high-interest savings accounts from our list and you’re earning 0.5% interest. For every $100 languishing in your savings account, your purchasing power declines by about $7 a year right now, assuming the rate of inflation isn’t even higher for the item you intend to purchase.
The temptation to do something else – or anything else – can be strong. But is there a realistic option for you in Clark’s mind?
Here are the Clark-approved places to put your money based on your schedule.
Less than a year: buy soon
Make your splash purchase in less than 365 days? Stick to High Yield Savings Accountssaid Clark.
Yes, inflation eats away at the value of your dollars daily. Yes, you earn a pittance by helping to provide banks with the cash needed to fund their loans. But you don’t want to lose the money you’ve earmarked for a major purchase so close to when you plan to make your transaction.
You won’t earn much (about $0.50 for every $100 over 12 months, less income tax). But it’s less risky and better than keeping the money in cash.
It is possible to explore shorter-term certificates of deposit (CDs). But if the interest rate goes up, you could be locked into a lower rate than what you would get from your savings account.
Short-term CDs (less than a year) often offer an incredibly low interest rate advantage. And even if you have six months or more, it can be nerve-wracking to lock those funds up unless you know your purchase date with absolute certainty.
One to three years: medium-term purchases
High-yield savings accounts are always an option, Clark says. Especially at the lower end of this range.
But you can add Series I CDs and Bonds to the list of options approved by Clark if your time frame is one to three years.
With a CD, you give up cash for a set period of time (barring financial penalty) in exchange for an interest rate that can exceed that institution’s APY savings account.
A Series I bond can be an attractive option if you expect inflation to persist for quite some time. Currently, the fixed rate of an I-bond is 3.56% every six months, or 7.12% per annum. This number will be readjusted every six months.
At a minimum, with Series I bonds, you’ll avoid a huge, inflation-induced loss of purchasing power on that money. This can be a big relief, especially when you’re tormented by inflation headlines every day, as interest rates remain historically low.
Keep in mind that you cannot cash in your Series I bond until the end of a year. And if you cash it in less than five years, you will have to pay a penalty equal to three months’ interest.
Three to five years: about to invest
If you’re so far away from your big purchase, you may be most tempted to take risks and be aggressive. And you’re not entirely wrong.
That’s a lot of time to leave large sums of money in a savings account earning less than 1% interest. And who knows how long large-scale inflation will last?
Good news: you can add very short-term bond funds to your arsenal of potential choices.
It’s important to stick to very short-term bonds, Clark says, because the time frame reduces your risk as interest rates rise. However, you could still lose money, especially in the short term.
For example, with heated talk of potential Fed rate hikes, the very short-term bond index fund Vanguard is down almost 0.6% in the first 53 days of 2022.
“The odds of you losing money over a three, four, five year period in an ultra-short bond fund – I mean, you should be the unluckiest soul to lose money over that period time,” Clark said.
It’s tempting to invest some or all of your money for a purchase in less than five years. But the shorter your available time, the higher your risk, even if you diversify your investment into a total stock ETF.
Fortunately, if your term is longer than a year, there are things you can do to earn more than the mediocre rates you’re currently getting on even the best savings accounts.
Incidentally, it’s not a good time to buy a car or a house from the start of 2022 due to inflation. These strategies could therefore be very useful to you if you are waiting for the markets to correct.