What comes to mind when you think investment portfolio? I think most people think of one big portfolio that takes care of everything. This is likely how most people put their money away but I think it’s important to divide your investment portfolio into parts as you likely have all sorts of goals from short, medium to long term. You obviously shouldn’t be taking money out of your long-term portfolio for short-term goals. So let’s talk about the different parts of your portfolio that you should consider.
I have some timeframes that I mention in this article and want to define them here:
Extremely Short: 1 week to 6 months
Short: 6 months to 3 years
Medium: 3-5 years
Long: 5+ years
Vacation, Leisure, and other Accounts: Extremely Short to Short Term
This isn’t exactly part of your investment portfolio, per se, but I wanted to touch upon this because these accounts or spending should be kept separate from your total investment funds. In others, when you come up with your asset allocation
Something I do personally and recommend is creating a savings account for different reasons. I have an account for leisure, music, vacation, big purchase, and gift and clothing. Yes it might sound excessive, but by having the different accounts it’s easy to keep everything organized.
The leisure account is for all leisure activities. Within my budget, I set aside a set amount of money to spend on going out for dinner, movies, concert tickets, etc from each pay check. This way you know exactly how much you’re allowed to spend instead of putting everything on the credit card.
I love music, so the music account is for anything music related. Itunes downloads, buying guitar accessories, buying new instruments, etc.
The vacation account is self-explanatory. I don’t put my vacation on my credit card and worry about it later, I plan and save for it beforehand and know exactly what I’m allowed to spend on the vacation. If you argue that it’s not as much fun this way, then I’m sure you enjoy looking at your credit card statement after your vacation. This is a sure fire way to stay within your budget on vacation. People tend to overspend on vacation as their sense of money becomes extremely loose. Think of it as a self-imposed vacation-spending limit. You’ll thank me later!
The big purchase fund is for purchases that you wouldn’t be making on a monthly basis. For me, this would be a decent pair of shoes, a new computer, or an iPad. Something worth saving for again every pay check I have a set amount going towards this.
The gift account is just as it sounds, for gifts. You could be saving up for Christmas, your significant other’s birthday present, or to give someone you see everyday a surprise gift. Giving someone something to smile about won’t hurt you.
Finally, the clothing account is also as it sounds. Instead of buying before you have the money, force yourself to save up for clothing first. Clothing ranks high on impulse purchases if you can cut back on a few pieces a year you could potentially knock off a few years of working to reach financial freedom.
Cash (Rainy day) Time frame: Short to Medium
I’m sure you’ve heard of the rainy day fund before. It’s recommended that you have 3-6 months of expenses in this account. Many people tell you to stick the money in a savings account just in case something happens. While this will depend entirely on your risk tolerance, I’m not a huge fan of keeping $6,000~$12,000 in a savings account getting dismal interest.
In my case, and I want you to take this with a grain of salt because it isn’t for everybody, I rely on my line of credit for emergencies. When I think about the opportunity cost of leaving that much cash in savings I’d much rather put the money into something that has a higher rate of growth. Mind you, my investor profile is definitely on the aggressive end so this isn’t for everyone. But at least ensure that you are putting your money into something with the highest interest rate possible. Your local bank’s savings account may not cut it.
Children’s education Timeframe: Mid to Long
If you have children and you want to help them through post secondary education, then this is a big one. There are a variety of estimates as to how much a 4-year college/tuition will cost but if we take one example, let’s guesstimate that it will cost $200,000. According to this US News article the average cost of public tuition could rise to $44,047 per year and that’s not including any living expenses.
You should setup a separate fund for your children’s education. In Canada, this is easier as the government helps fund your children’s education by matching a percentage of your contributions to the Registered Educated Savings Plan (RESP), which is adjusted according to your income level. Check to see if your local government has something like this in place.
To do some numbers, if you do need the $200,000 and your child is 0 and expects to go to university at the age 18 you have 18 years. If you can get a return of 6% annually, what sorts of monthly contribution do you need? The answer is $516.32 per month.
Or you consider how much you can afford to put away. Can you afford a $100 per month? With the same 6% return for 18 years, you’re looking at $38,735.32.
Starting your own business: Mid to Long
If you want to eventually start your own business, you should have an investment plan for that. Sure you might be able to borrow from the bank when the time comes, but from experience it’s often very hard to borrow from the bank for a start-up company unless you have angel investors lined up.
Retirement Timeframe: Mid to Long
This is likely the core of most investment portfolios. Most of us don’t want to work forever or want to follow a lifelong passion and need the freedom to do so. Be sure to read how to come up with your magic number to reach financial freedom. While many know that they need to put money away they don’t know how much they need or how they can achieve it.
As you can see, an investment portfolio can have different portions and each portion will have a different purpose and therefore timeframe. Timeframe is extremely important because the longer the timeframe, the more risk you could potentially take with that portion of the investment portfolio. If you only had 6 months until you needed the money, your investment options are very limited. But if you had 15 years then you have numerous ways to invest your money.
Do you invest your money for something that isn’t listed here?