IF YOUR TIME HORIZON is five years or less, the big threat can be summed up in two words: losing money.
To get a sense for the range of potentially rotten returns, consider the worst annual returns for some of Vanguard Group’s mutual funds. In 2008, when the financial crisis hit with full fury, Vanguard’s S&P 500-stock index fund declined 37%, its small-company index fund fell 36.1% and its total international-stock fund tumbled 44.1%. And these numbers don’t fully reflect the punishment suffered: The market’s slide started in late 2007 and continued into early 2009, before global stock markets bounced back beginning in March. The S&P 500’s peak-to-trough price decline was a staggering 57%.
For bonds, 2013 was a rough year. How rough? Vanguard’s long-term Treasury fund fell 13% that year, its inflation-indexed bond fund slumped 8.9% and its long-term corporate bond fund slid 5.9%. Vanguard’s high-yield corporate bond fund, which invests in low-quality “junk” bonds, made money in 2013, returning 4.5%. Instead, its rough year was 2008, when it fell 21.3%, reflecting junk bonds’ tendency to trade more like stocks than bonds.
Want to see how your funds performed each calendar year? You might check the website for the fund company involved or head to Morningstar.com.
The bottom line: If you have money that you’ll need to spend in the next five years, you probably shouldn’t own anything riskier than short-term bonds. The worst annual performance of Vanguard’s short-term corporate bond fund was a 4.7% loss in 2008—and it easily recouped that loss the following year. Vanguard’s short-term Treasury fund has given shareholders an even smoother ride, including notching a 6.7% gain in 2008’s turbulent market.
For greater safety, you might go for money-market mutual funds, which strive to maintain a stable $1 share price, or even an FDIC-insured savings account or certificate of deposit. One tip: You may find you can come out ahead by buying longer-term CDs, with their higher yields, even if you have to cash out before maturity and pay an early withdrawal penalty.
Next: Long-Term Threats
Previous: Step 1: Goals
Article: Bearing Gifts