Where should I Invest my Short-Term ‘Stash?

Welcome to the third post in the Investment Series. For those just joining us:
Article 1 told you why investing in stocks is actually pretty simple, and
Article 2 described the volatile nature of stock returns.

So we’ve established that while long-term stock market returns have been quite predictable for over 100 years, with an after-inflation return of over 7% per year, we’ve also noticed that they fly up and down in an absolutely random manner in the short term. And “the short term” can actually mean periods of up to 15 years.

So: for long-term savings, like the money you are saving in 401(K)s, Roth IRAs, Canadian RRSPs and such, stocks are still the best balance of large long-term gains versus risk. You’ll see some alarming swings if you check the stock prices every day, but if you just open up your statement on the day you turn 59.5 to start your withdrawals, you will probably be pleasantly surprised.

What about money you need for more immediate needs? Say you are saving for a house downpayment that will take two years to accrue. Or you received a gift from your grandma to pay for your college education, but you won’t even be graduating from high school for three years. Here is a list of investment types and their current approximate return rate, listed in order from safest to most volatile (and most rewarding over time):

No Volatility:

  • Bank Accounts: the best I know of is ING Direct Orange Savings account – still only 1.0% right now. Checking accounts don’t deserve ANY of your money – enough to handle the monthly automatic-bill-pays only.
  • Money Market Funds (such as Vanguard’s Prime Money Market Fund) have historically delivered higher returns than savings accounts but not with today’s lowest-in-history interest rates. Less than 1.0%, so skip ‘em for now.
  • Certificates of Deposit - where your money is locked up for a specified time period in exchange for more return. I just copied the following rates for today from www.google.com/advisor/uscd
1-year CD 1.31% APY ($1000 min. balance)
3-year CD 2.00% APY ($500 min. balance)
5-year CD 2.75% APY ($500 min. balance) 


  • And, of course, the best guaranteed no-volatility place to invest your money may be paying off existing debt. Your mortgage, your student loan, or if you still have superbad loans like car or credit card debt, you need to get on those, emergency style, before you consider saving for anything else.

As I suggested in an earlier article called “springy debt instead of a cash cushion“, until you are completely debt-free it may make sense to use a line of credit as your cash cushion instead of short-term savings. Because which one makes more sense: saving for an upcoming purchase in a 1.0% bank account while simultaneously paying 4.5% on your mortgage, or putting all the short-term money into the mortgage and just borrowing back whatever you need at 3.25% in the form of a line of credit? Another reason I like this approach is that it reminds you that until you are mortgage-free, you are effectively borrowing for everything you buy. Not necessarily bad, but it is good to be reminded of this when you’re at the pub deciding whether or not to spring for another pitcher.

Medium Volatility/Medium Returns

  • High-quality corporate Bonds: These have recently delivered a 4-5% return and yet are much less jumpy than stocks. Take a look at the ten-year performance of a suitable Vanguard Bond fund (VFSTX) compared to my favorite big US index fund (VFINX):
  • After looking at that 10-year comparison, you might wonder “why would anyone buy stocks when the bonds do so well?”.  The answer lies in the longer term. Since its inception in 1976, the stock fund has compounded at 10.72%, while the bond fund (started in 1982) weighed in at only 6.99%. Over a 30-year period, a single $100,000 invested in stocks would have become $2.1 million, meanwhile a bond investor would only have $759,000. Still, for 1-3 year savings with a still-reasonable return, I’d feel fairly happy with the bond fund myself.

    • Mixed Stock/Bond Funds: Vanguard’s VBINX is a mixture of 60% large company stocks and 40% investment-grade bonds. In bad markets, it is safer than VFINX. In good markets, it underperforms the pure stocks.

    For someone like me who wants a growing-but-semi-stable pool of money to use up over the next 5-10 years, a mixed fund can be a good choice. I can leave my long-term “old-man” money in stocks, but keep 5 years of living expenses in a mixed fund like this, and automatically make monthly transfers to the checking account to fund regular living.  In the event of a stock market crash in the long-term investments, the VBINX takes a much smaller hit and thus principal is preserved. Then I could wait at least 5 years for a recovery in the main market before topping up this fund again.

    Hint: If you want to do a little fund shopping of your own, you can play with the same web site I used to generate the graph above. Start here and then start clicking around on fund types, or type a fund symbol into the box. Then you’ll see a “growth of $10,000″ tab which will get you into the nice charts.

    In all cases, do your own math on short-term savings and figure out how much you expect to earn from the investment. If you’re just saving to buy a tricycle for your daughter next month, or a $5000 used car in three months, there is not much benefit in worrying about investment returns.

    Also remember that the more you cut your spending in general, the faster your savings accrue, meaning you don’t have to think about saving as much. Some dual-income families need to plan months ahead even for a new washing machine, while their Mustachian counterparts could buy an entire car with less than a month’s notice, and the only effect would be that they would pour less into their long-term investment accounts that month.  This flexibility and convenience makes your life much simpler and happier – yet another reason frugality rules.


    • Chris June 7, 2011, 12:22 pm

      US savings bonds didn’t make the cut? I-Bonds pay a variable rate, and can be cashed in within a year. The rate resets every 6 months, and can never be < zero. In the 6-month period starting in May, the rate is 4.6%. In the worst-case scenario, the following 6-month period would be 0%, which would still give you a better than 2% rate over the course of the year.

      In many ways, I-Bonds (at the current rate) are better than CDs: $25 minimum, tax-deferral, and no state income tax on the interest. One drawback is the $10k purchase limit per year, but you can double that if you're married (the limit is per-SSN).

      • MMM June 7, 2011, 12:32 pm

        You are right! Mr. Money Mustache loses some points here. I did look into US treasuries from treasurydirect.gov, and I know many investors use them. But I found the website confusing and non-intuitive so I was hesitant to recommend it. With so many choices, and so much apathy towards investing, I want to focus on easy things whenever possible.

        But if you can suggest a good website to learn about/invest in the bonds you mention, let me know and I can update the article.

        • Steve June 7, 2011, 2:29 pm

          Pain in the ass you mean. I buy from that site and I hate it. In order to log in to my account, I have to get a special card from my safe that is similar to save points of video games…where they ask me to look in certain boxes and provide them with the result.

          I mean it’s safe…but Jesus Christ…I just want to check my balance already.

      • Steve June 7, 2011, 2:27 pm

        The other drawback is that Ibonds purchased now have a 0% fixed component. You will need to sell them which is a bit of a hassle, unless the inflation component begins to pay more than it has historically.

        I’m making over 3% on some of my ibonds that have a higher fixed rate right now. I’m a little reluctant to max out Ibonds this year with a fixed at 0%, knowing I’ll lose 2 months interest when I sell them, when I can buy CDs at 2.5% and hold them until a better rate comes along.

    • Jess June 7, 2011, 12:50 pm

      What about from a tax standpoint? If these are going into a taxable account, since they are short term funds, which of these would be most tax efficient?

      • Kira July 6, 2014, 9:18 am

        Tax strategy is a little more individual to each person’s situation because of all the nuances. You’re probably best off speaking with a tax advisor/CPA.

    • Kevin M June 7, 2011, 12:55 pm

      My dilemma is our so-called “emergency fund”. We keep basically 6 months of expenses here, plus we have another $5k (almost) saved in our HSA to pay a medical deductible should disaster strike. Part of me doesn’t like that $25k sitting around earning 1%. I’m tempted to throw part of the $20k into a short-term bond fund and try for a little more return. The other part says “shut up” and don’t worry about return, worry about safety and liquidity. We are debt free, except our mortgage at 4.825%. My job is about as stable as it gets. I am next in line to succeed the current owners, unless the business unexpectedly fails.

      • MMM June 8, 2011, 10:20 pm

        Hi Kevin! .. Just working through some of the recent comments and I must have missed yours.

        I think your emergency fund is costing you quite a bit of money. Since emergencies bigger than what you could handle with just a credit card, paid back in full with your monthly income, are probably incredibly rare, I would feel very safe having it in a bond fund. In the worst case, you would have to cash it in and it may be worth a teeny bit less than you bought it for. This is much better than your current situation, where you are GUARANTEED to earn several percent less per year on the emergency fund, forever – costing you $600 per year or more in foregone investment gains. Emergency funds are great for people just starting out and living on the very edge. But when your emergency fund is the size of a 2007 Mercedes, things are getting crazy.

      • April October 17, 2011, 12:44 pm

        First off, I’m loving your blog! My question has to do with paying off ones mortgage. I’ve read several times that you recommend this. I have about $45k in high yield checking accounts earning 2% as long as I meet the requirements (10 debit transactions, electronic statement, direct deposit) which is never an issue. I have thought about putting this money into paying down my mortgage (only $79k at the moment at 5.125%) but have been advised against this by every financial planner I have spoken with. Their argument is that the money would make much more than the 5.125% in the stock market or other investments over the 30 years my fixed mortgage is for (about 28 years left as of today), that the money is very difficult to pull out again if needed (my biggest concern), and that keeping a mortgage has benefits in regards to inflation-though at the moment I can’t recall what those were.

        I do not have any debt other than the mortgage. I clearly agree with your buy it with cash (or via a credit card that is paid in full each month) or don’t buy it at all philosophy.

        • MMM October 17, 2011, 8:05 pm

          I would definitely pay it off! With that $45k and a few extra payments, you’ll be mortgage free very soon! It is EASY to pull any amount back in the form of a line of credit, which would have an interest rate much lower than the punishing 5.125% rate you currently pay.

          You may or may not make more money in stocks in the long run, but a 5.125% Guaranteed return is great. Think of it as a stable dividend-paying portion of your portfolio. Then load up on stocks once you are mortgage-free (and maintain regular 401(K) payments for the longer term, even now).

          • April October 24, 2011, 10:11 am

            Can you give some additional information about how one would setup a line of credit? It makes me uneasy to take everything out of the bank and stash it in a very unliquid asset (house).

            My other concern is that I am currently looking at some nicely priced investment properties in my area. If I find one that meets the 50% & 2% rule nicely, I’ll need cash for the downpayment as well as remodeling. If I put the 45k in my current house, would I then use the line of credit to pull the money out again?

            I am very unfamiliar with this line of credit idea. Please explain.

      • DP January 26, 2012, 1:37 pm

        My understanding is that with an HSA you can actually invest your funds once they exceed a certain amount. I think it’s currently $2000. And apparently you can automate a process by which your bank “sweeps” your account anytime the balance exceeds $2K and puts the excess into your investments.

    • Bakari Kafele June 7, 2011, 9:51 pm

      June 7th!! I finally made it to the current days post! I don’t think I have ever caught a blog (that is updated so frequently) early enough to actually read every post. But here I am.

      • MMM June 8, 2011, 10:13 pm

        Hey, congratulations! Your unparalleled dedication to the MMM blog makes you part of a rare breed. I hereby grant you the status of Senior Mustachian!

      • Kira July 5, 2014, 8:07 pm

        I”m three years behind, but I’m determined to get caught up…

    • Leni June 8, 2011, 7:38 am

      I like the formula for investing of my father, he suggests in addition to a dollar-averaging-program using your security-emergency fund for short term investing once you have enough other liquid asstes to cover an unexpected emergency. using the s&p 500 as a barometer, invest 1/3 of your security-emergency fund when the s&p goes down 10%. This in addition to your regular monthly investment. if the s&p goes down another 10%, invest the remaining 2/3 of your security-emerg. fund. Since the s&p will swing up as well down, it represents a picture of the total economy. Using this formula, this is your real opportunity. What if the s&p falls another 10% or more? in that case my father suggests you borrow twice as much as your last investment (2/3 of your total sec.-emerg- funf) and invest it. This give your capital a real boost. in the last 100 years 30% corrections are quite infrequent.

      • resiliantrene June 7, 2012, 4:38 am

        Hello Leni,
        I know you wrote this comment last year, but I am just getting around to reading this particular MMM post and its corresponding replies. I like your Dad’s idea about investing the emergency fund in the stock market when it drops. My question is: do you then leave those portions of emergency fund in the stock market for a year to avoid short term capital gains? I hope you see this post!
        Thank you!

        • Kira July 6, 2014, 9:21 am

          resiliantrene, you really need to speak to a tax advisor regarding the best strategy for you regarding short- vs. long-term capital gains.

          • resiliantrene July 8, 2014, 6:54 am

            Thanks, Kira, for weighing in on my question. Of course you are right.

    • Patrick June 9, 2011, 3:27 pm

      So your saying its bad to have two 2007 Mercedes in my emergency fund…and you want me to pay down my 3% mortgage? I’m talking with the DW right now…

      p.s. Love the blog. Better reading than ERE – ‘cooler’ than Simple Dollar.

      • MMM June 9, 2011, 4:24 pm

        Hi Patrick, thanks very much!

        Yeah, those fifty thousand employees of yours are doing a lot of smoking and hanging out by the pool table right now. I don’t know what your own life situation is, but I have never felt the need for a gigantic emergency fund in non-interest-bearing cash. I DO feel great reassurance having lots of savings that would back me up in an emergency. But I still want the savings to be working for me – whether in the form of a more-paid-off house (with an optional line of credit for emergencies), or a larger non-retirement investment account with various index funds and bonds, etc. You can STILL get money out of these other sources.

        In fact, I recently DID have an ‘emergency’ where I had to fully pay off the mortgage on a rental house due to a (long-story) business situation. I sold some funds, and there was the money just a few days later! The stocks were far down from their peak of 2007, but it still worked out far better than having all the savings in a checking account this whole time. And most people will not be as foolish as me in inflicting a multiple-hundred-thousand-dollar emergency on myself!

    • Pachipres June 13, 2011, 10:23 am

      We have gotten ourselves in a finanical dilemma that we are committed to changing but we need some advice.

      We took 15k out of retirement portfolio plus we are maxed out on our credit line of 10k. We also have another 11k on t he Visa. So overall we are about 36k in debt. We are now paying 6.5% interest on this credit line. We were thinking of paying the $150 fee(CAN) to open up a secured line of credit where interest is 4%. and consilidate all the debt in one place. I am not sure we should do this or just take more money out of the investments to pay this Visa and then slowly try to get out of debt.

      Would appreciate any feedback here.

    • Enginerd September 3, 2011, 10:31 am

      MMM, while I admire your overall approach in getting people to invest, I have just one small disagreement- that you should “always” buy an index fund instead of individual stocks. Now hear me out before you flip- I’m not talking about buying stocks you heard about on TV, your friends, “some guy” your friend knows, etc.
      First, dollar cost averaging does not make sense to me. If prices are high, why balance them out with prices that likely will be lower later? Why not reduce (not necessarily stop, just reduce) the amount of money put towards the investment so you can buy more when it starts to go down? To put it in Mustachio terms, you’re basically saying that you’re willing to pay any price for your index fund. You stock up on items when they are on sale at the grocery store, I would think you would want to approach the market in a similar fashion.
      Second, it is a fact that some companies are simply better than others, and you can see some of this through simple things like increasing earnings per share on a consistent basis, and revenue growth. Yes, it will take some homework and time to sort these out. No, most people don’t want to spend the time doing this. But the fact is, when you own an index fund, you own stocks in companies that are failing, losing market share, having accounting scandals, etc. Basically you are knowingly buying the losers along with the winners. Now, i’m not advocating throwing money into a bunch of individual stocks with reckless abandon. However, I feel better in looking over companies myself and building a diversified portfolio. That way, if my investments tank (which is highly unlikely, will explain shortly) at least it will be my responsibility and not because I knowingly bought the bad with the good, the bad which perform especially bad in a downturn and drag down index funds.
      Now, what I think you are missing in your investment strategy, although you do mention it from time to time, is dividends. While index funds do pay dividends, they tend to only be about 1-2%. Several stable individual stocks pay in the 4-6% range- utility companies, the main telecoms (Verizon and AT&T), tobacco companies, oil&gas master limited partnerships (MLP). In a flat or volatile market, these are your best friends, as the dividend yield increases as the stock price goes down. This “dividend parachute” will also slow the decline of a stock if the general market is taking a horrible beating, as the stock becomes much more attractive as the price drops and the dividend increases. That way the price of the stock is more stable and you get paid more. However, these stocks do tend to stagnate during periods of high growth, as people will take money out of these and into faster growing stocks. Having about 5 high dividend yielding stocks from different sectors will outperform a stagnant market, and will usually outperform a volatile one. This is of course assuming that you re-invest the dividends to increase your dividend payments over time. Again, I am not saying it’s easy to outperform the market, but this will put you in a very good position to do so if you do the work.

      • MMM September 3, 2011, 12:09 pm

        Your points are all spot-on as part of the methods one would go about if they wanted to beat the market with their individual investing prowess. The only problem is, a shocking number of massive and rigorous academic studies show us that we ALL vastly overestimate our own ability to beat the market, and the 50% or so that do so by chance, attribute it to their investing skill rather than chance. John Bogle, the founder of Vanguard who ran it for 40 years or so, says this on the matter, “Not only do I not know anyone who is able to consistently beat the market on a risk-adjusted basis, I don’t know anyone who knows anyone who can do this.

        Having said all this, I still intuitively believe I can personally beat the market. And I even dabble a bit on the side with some timed purchases to try to do so. But knowing the research and knowing that I am a human who overestimates my own skill, I make fun of myself while doing this, and consider it an entertainment and gambling exercise.

        You must at least carefully read “A Random Walk Down Wall Street” to see if you believe the studies. Personally, I tend to believe scientific studies over my own intuition in most cases. That’s how we get ahead as a species – science.

        • Enginerd September 3, 2011, 12:48 pm

          I have read some studies. The problem with the data in this case is when and how you choose to look at it. For example, if you did a study from 2007 to 2011 (until about a month ago), you would conclude that stock prices do not significantly trend over time, they just fluctuate, as the S&P is largely unchanged due to the crash in 2008 and subsequent recovery. Or you could study 1930′s until 2007 and calculate an average rate of return and conclude that “buy and hold” is always the best investment method. It really depends on when you put the markers on index funds and when you actually bought and sold certain stocks when doing a study.
          Fund managers move a lot of money and leave points on the table when making trades, as they influence the price of the stock by buying or selling. The individual investor does not have this problem. These changes can easily be the difference between matching the market or beating the averages by a few points.
          As for people who beat the market over time, it all depends how you define “time.” Successful hedge funds beat the market all the time for years on end. You never know if they can do it for a 20-30 year window, as most either have a bad year and get wiped out by investors pulling money out like a bank run, or retire after 5-10 years as this is an incredibly stressful profession.
          While I don’t claim to be a stock guru, it is a hobby of mine, and like yourself I enjoy seeing if I can beat the averages. I do keep a large portion of retirement savings in more stable funds, and have some fun with non retirement accounts. I also completely agree with you that controlling spending is far more important than trying to win with investments, and I really enjoy this blog. Keep it up.

    • Mark May 22, 2012, 8:46 pm

      Would you recommend stashing savings in a bond fund for people without sizable cash-on-hand savings? Is this a good place to start, or should it be on top of a X-months of expenses savings account?

      My wife and I are cutting costs left and right, so I am expecting to see a small monthly accumulation. Our current savings would be about 1 month of the bare minimal monthly expenses (mortgage and ramen). I would like to split our freed up income 3 ways between savings, paying down mortgage principal, and putting a little into a Roth IRA. I have good job security for 1 year (and reasonable for 2).

    • hands2work September 7, 2012, 10:33 am

      how do you feel about cd ladders? waste of time or good way to stash your money at a higher rate while keeping a rolling liquid amount?

    • SKRL February 12, 2014, 2:58 pm

      HI MMM,

      Going through all the blogs from the beginning.

      My scenario, pls. do let me know your thoughts:

      I am from India, but have been living in the US for about 6 yrs now, and plan to stay here longer or may be even for good.
      Now, as I am not a US citizen still I have the option of investing in India as well, which is a growing economy, just the fixed deposits (CD’s) earn me around 8.75%. I also have opened a vanguard fund account and keep investing a regular weekly stream.
      My question is would it make sense for me to just invest in the fixed deposit in India & make a flat 8.75% without any risk apart from the currency frequency (which sometimes can be volatile) or just go with vanguard for a 6-7% in the long run, which I might or might not make.
      What are your thoughts?

      Also, I can get a little aggressive & even invest in mutual funds in India, which can get me around 15-20% return, but again the currency fluctuations are a risk.

      I would really appreciate your comments/thoughts.

    • Brian May 12, 2014, 1:44 pm

      Hi Mr. Money Mustache! I think this may be my first comment but I’ve been reading lots of your blog this past year. Thank you for so much amazing information!

      I’m at a point where I have an adequate-sized emergency / short-term savings fund at a local bank and I’m looking for where I should now put the monthly income that I was devoting to that account (since the interest rate is insanely crappy). I already have a ROTH IRA with Vanguard and was originally thinking about opening a separate non-retirement account with them as more of a “mid-term savings fund” or hopefully my “pre-age-65 early retirement fund” – using the Total Market Index Fund as you had suggested in another article. Anyway, the more I think about it, it seems like it would actually make the most sense tax-wise to dump the money into my ROTH IRA since I could withdraw at least the principal if I really needed it without being taxed. I guess my question is, are there any advantages to saving money in a non-retirement account with Vanguard or does the ROTH IRA sound best? The only advantage I can see is that perhaps you’d need something like that if you already contributed the yearly max to the ROTH IRA. Thank you very much!


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