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I am looking to save for a down-payment for a house in a period of 1 to 2 years.
So I want to open a brokerage account, start with $3K, and put $1K on a monthly basis. Then, after one or two years, I want to take out the money, plus any earnings I made.
My question is - what types of funds (or combination of funds) should I choose for this short-term goal? Should I choose mutual funds or index funds? This is my very first attempt in investing, by the way. Thank you very much.
1-2 years is very short-term. If you know you will need the money in that timeframe and cannot risk losing money because of a stock market correction, you should stay away from equities (stocks).
A short-term bond fund (like VBISX) will pay around 1%, maybe a bit more, and only has a small amount of risk.
Money Market funds are practically risk-free (technically speaking they can lose money, but it's extremely rare) but rates of return are dismal.
It's hard to get bigger returns without taking on more risk.
If you are looking to invest for 1-2 years I would suggest you not invest in mutual funds at all. Your time horizon is too short for it to be smart to invest in the stock market.
I'd suggest a high-yield savings account or CD. I know they both have crappy returns, but the stock market can swing wildly with no notice. If you are ready to buy your house and the market is down 50% (it has happened multiple times in history) are you going to have to put off buying your home for an indefinite amount of time waiting to them to recover?
If you are absolutely committed to investing in a mutual fund anyway against my advise I'd suggest an indexed fund that contains mostly blue chip stocks (indexed against the DOW).
A bond fund like VBMFX or similar I think are a good choice. Bonds are far less volatile and less risky than stocks. With your 1-2 year time frame, I say definitely stay away from stocks.
If you are younger, and you not under undue pressure to buy a home at any particular time, investing in the market is a reasonable way to prepare. Your risk tolerance should be high.
Understand that this means you may buy in 3-4 years instead of 1-2 if the market takes a down turn. It took ~3-4 years for the S&P 500 to recover from the 2008 crash. I doubt anything that severe is in the making, but there is always an element of risk involved in investing.
If you and your family will be busting at the seams of your current rental in a year, then maybe the bond fund advice others have provided is a better option. If you are willing to be flexible, a more aggressive strategy might be appropriate.
Likely, you want something along the lines of the Vanguard S&P 500 mutual fund - something that is diversified (a large number of stocks), in relatively safe companies (in this case the 500 companies that Standard and Poor's think are most likely to repay corporate bonds), and 'indexed' vice 'actively managed' (indexed funds have lower fees because they are using 'rules' to pick the stocks rather than paying a person to evaluate them.)
It's going to depend on you and your situation - and regardless of what you choose consistency will be key: put your investment on automatic so it happens every month without your input.
If you want to invest in the stock market, whether over a shorter period of 1 to 2 years or over a longer period of 10 or 20 years or longer you need to take some precautions and have a written investment plan with a risk management strategy incorporated in your plan.
Others have said that 1 to 2 years is too short to invest in the stock market as the stock market can have a correction and fall by 50%. But it doesn't matter if you invest for 1 year or if you invest for 50 years, the stock market can still fall by 50% just before you plan to withdraw your funds.
What you need to figure out is a way to get out before the market falls by 40% to 50%. A simple way to do this is to use technical indicators to warn you when a market trend is starting to change and that it is time to get out of the market.
Two simple indicators you can use on a market index are the Rate of Change (ROC) indicator and the 100 week Moving Average (MA). Below is a 10 year weekly chart of the S&P500 with these two indicators charted. They show good times to get into the market and good times to get out.
If you are using the 100 week MA you would buy in when the price crosses above the MA line and sell when the price crosses below the MA line.
If you are using the ROC indicator you would buy in when the ROC indicator crosses above the zero line and sell when the ROC indicator crosses below the zero line.
So your investment plan could be to buy an Index ETF representing the S&P500 when the ROC moves above zero and sell when it crosses below zero. You can also place a trailing stop loss of 10% to protect you in case of a sudden fall over a couple of days. You can manage your investments in as little as 10 minutes per week by checking the chart once per week and adjusting your stop loss order.
If you want to progressively add to your investment each month you could check the charts and only add any new funds if both the ROC is above zero and sloping upwards. Another option for adding new funds could be if the price is above the MA and moving further away from the MA. All these rules should be incorporated into your investment plan so that you are not basing your decisions based on emotions.
There are many other Technical Analysis Indicators you could also learn about to make better educated decisions about your stock market investments. However, what I have provided here is enough for anyone to test over different indexes and time frames and do their own paper trading on to gain some confidence before placing any real money on the table.
