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Course 209
How to Invest for Intermediate-Term Goals

Introduction

Perhaps your daughter will leave for college in six years and you're only beginning to invest for the big event now. Or your know you'll need a new Jaguar in seven years to help cope with that mid-life crisis that's likely to strike. Or you're serving a prison sentence with eight years remaining and you want to have enough dough to start your life anew.

Despite the very different goals outlined here, each scenario shares a common theme: Each involves intermediate-term investing.

This course will cover how to invest for a goal that's five to 10 years away.

Start with the Right Mix

As with long-term investing, intermediate-term investing begins with determining your goals, and how much money you need to meet them.

If you know how much money you'll need to fund your goal--say, the money down you'll need for that Jag--you can use asset allocation tools such as Morningstar.com'sAsset Allocator to find the asset mix that will allow you to come closest to your goal.

To review how to determine your asset allocation as well as how to use Asset Allocator, refer to Portfolio 105: Determining Your Asset Mix.

But maybe the amount of money you'll need for your goal is unclear, or maybe you're flexible about the amount. You probably won't need a set amount when you walk out of prison, for example--you just want more than you have now. Or you know you won't be able to accumulate the $150,000 that you'll need to send your daughter to college in six years, so you'll take whatever you can get.

In these cases, you'll need a portfolio that falls between the short-term portfolio and the long-term portfolio--one that combines elements of the two. Investors with short time horizons use bonds or cash to preserve their money; those in for the long haul usually rely on higher-returning stocks, because they have the time to recoup any losses. In-betweeners should use stocks to grow their money and bonds to protect what they make.

Many advisors recommend that intermediate-term investors put 25% of the money in a safety net of bonds or cash and the remaining 75% in stocks. Those worried about risk might want to place 35% of their portfolio in bonds or cash.

Which Investments to Choose

You could just stick the low-risk part of your portfolio in the bank, but why not eke out some additional gains without much more risk?Take a look at Portfolio 208: How to Invest for Short-Term Goals for other short-term options.

Stocks are the way to go in the return-generating part of your portfolio. Most investors should opt for stock mutual funds rather than buying stocks directly. Mutual funds offer instant diversification, which is extra-important for intermediate-term investors. In-betweeners can't ride out volatility and take risk the same way that investors with longer time horizons can.

Specifically, large-cap blend funds make the most sense for intermediate-term investors. They invest in the core of the U.S. market and include value and growth stocks among their holdings, making them steadier than most stock funds are when the market hits a rough patch. Large-blend funds tend to be less risky than all other types of U.S. stock funds.

What About Balanced Funds?

A balanced fund is another option for intermediate-term investors. Balanced funds, which are often called hybrid funds, own both stocks and bonds. They earn the "balanced" moniker by keeping the balance between the two asset classes pretty steady, usually placing about 60% of their assets in stocks and 40% in bonds.

For some in-betweeners, though, that stock position may be too small. Many balanced funds hold larger stock positions, however. Review a balanced fund's portfolio holdings to find out how largeits stock position is. (Morningstar divides balanced funds into two categories: conservative-allocation funds, which hold only 20%-50% of their assets in stocks, and moderate-allocation funds, which are more aggressive, holding 50%-70% of their assets in stocks. Most balanced funds' names won't indicate whether they are conservatively or moderately allocated, so you'll need to check their Morningstar category and dig into their portfolio holdings to investigate.)

The downside to balanced funds: costs. You can often buy a short-term bond fund and a large-blend fund and pay less in annual expenses than if you'd just bought a balanced fund.

But balanced funds are certainly convenient, and they're not all high-cost. We've put together a list of modest-cost balanced funds using Morningstar.com's Fund Screener. Here's what we did:

  • Go to the Fund Screener
  • Under Fund Group, choose Balanced.
  • Under Morningstar Category, choose Moderate Allocation or Conservative Allocation.
  • Under Expense Ratio Less Than or Equal To, choose Category Average.
  • Under Morningstar Category Rating, choose 4 and 5.
  • Hit Show Results.
  • From the Results Page, click on the Expense Ratio (%) column to rank the list from lowest to highest expense ratios.

You can manipulate any of the inputs, if you'd like, narrowing your search even further.

Premium Members can also find a list of the balanced funds Morningstar fund analysts like best in our Fund Analyst Picks. (This is a benefit of Premium Membership, but nonmembers cansign up for a free trial.)

Quiz 209
There is only one correct answer to each question.

1 Intermediate-term investing begins with:
a. Choosing the right investment
b. Determining your goals and what they'll cost
c. Buying a balanced fund
2 What if you don't know how much money you'll need in seven years?
a. Invest everything in stocks
b. Invest everything in bonds and cash
c. Invest 25% or 35% in bonds and cash and the remainder in stocks
3 What is the best investment option for the growth portion of an intermediate-term portfolio?
a. A large-cap blend fund
b. A technology fund
c. Small company stocks
4 What does a balanced fund own?
a. A balance of stocks
b. A balance of bonds
c. A balance of stocks and bonds
5 Why may balanced funds not be the ideal choice for intermediate-term investors?
a. The stock positions of many balanced funds are too small.
b. Balanced funds are too expensive.
c. Both A and B.
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