Got long-term savings to invest? We'll help you figure out where to put it. But first, let's talk about what long-term savings means.
What is "long-term" savings?
- Bond investors consider anything 10 years and over to be "long-term."
- Many regular consumers think of long-term savings as something that won't need to be accessed in the next five years.
But instead of getting technical with the length of time, let's think about the sorts of reasons we might be saving long-term:
- For retirement; the length of time will depend on your age and how much you want to save.
- For college; it will be pretty obvious, based on your children's ages, how long you'll need to save! We'll assume your children aren't in high school yet if you're thinking of their college funds as long-term savings.
- For a major purchase, such as buying a home or starting a small business. If you're planning at least five years out to save up a down payment for a home or other major purchase, we'll classify that as long-term savings.
What shouldn't be considered long-term savings: your emergency fund, a savings account to buy something like a car, or anything you'll need to access in the next few years.
Where should you invest long-term savings?
With long-term savings, you have more flexibility than with short-term savings, and along with that, most long-term investors have more risk tolerance. In other words, since you won't have to access your funds for many years, you don't freak out if some years, your investment temporarily drops in value.
Why? Because historically the average return of stock market investments, over many years, has been positive. So, while short-term savings might be better off in a money market fund or a CD, long-term savings might be more appropriately invested in index funds, mutual funds or bond funds.
The type of investment depends on your goals
As with any investment, it's important to find the right vehicle to fit your goal.
- For retirement and other investments that will need to produce income many years from now, choosing a tax-deferred account such as a traditional IRA or 401(k), or a Roth IRA with tax-free withdrawals (under certain rules) is the best option for most consumers. Once the account is established, most experts suggest selecting an assortment of mutual funds - especially index funds - and bond funds that will match your desired return with your ability to accept risk.
- For home purchase accounts and other short-term goals where you're building up a lump sum (like a down payment), a more conservative approach is sensible. Many Get Rich Slowly readers suggest a high-yield savings account which pays higher interest than a regular bank savings account, or an assortment of CDs called a "CD ladder."
- For college savings, most states offer tax-deferred or tax-exempt savings plans called 529 plans. These are often the best choice thanks to the tax break; but some have a lot of restrictions and a few have had fund management scandals, so you should do your homework on your own state's plan. If your children are still quite young, many of the same investments typically chosen for retirement accounts could be a good choice (like index funds). As your kids grow, consider moving more of their college savings into conservative investments such as CDs and high-yield savings.
This Guide to Money answer includes the topics: Invest.