Investing short-term to pay for travel costs?

[mrmatt]

Hello all,

This semester in college (my last) I am taking a personal finance course that has developed an interest in me in personal investing and budgeting.

I am planning to spend about a month in Europe in the summer of 2012. I am considering investing a few hundred dollars in a mutual fund to generate short-term gain that I could use while on this trip. Thus I have a about 14 months of growth.

Can anyone recommend a specific fund or type of fund?

[jpg7n16]

You always want to match your investments to your time horizon. Your need is 14 months away, so you need an investment that is geared for 14 months.

Stocks are ownership of a company and thus require a long time to pan out. Recommended for 5+ years away. Stock mutual funds are the same.

Bonds vary by issuance, or remaining term of the bond. These could be anywhere from maturing soon, to 30 years away. Bond mutual funds come in 3 usual classes: short term (1-2 years), mid term (2-5 years), and long term (5+ years).


The options suitable to your timeframe are: just literal cash, a bank savings account, a Money Market fund, 12 month CD, or a no-load short term bond fund (duration of less than 14 months).

I'd probably go with the no load short term fund, or the Money Market.

[disneysteve]

The options suitable to your timeframe are: just literal cash, a bank savings account, a Money Market fund, 12 month CD, or a no-load short term bond fund (duration of less than 14 months).

I'd probably go with the no load short term fund, or the Money Market.

I agree with the theory but I would not pick the bond fund in this case. As rates rise, bond values will fall and I think there is a reasonably good chance of a bond fund, even a short-term one, losing money in the next 1-2 years. I'd go with the money market if you want to keep adding to the account or a CD if you have a lump sum to set aside right now.

[jpg7n16]

As rates rise, bond values will fall and I think there is a reasonably good chance of a bond fund, even a short-term one, losing money in the next 1-2 years.

That's why the duration of the fund is super important. Using an appropriate duration can immunize the portfolio against interest rate risk.

What Is Bond Immunization?
Advanced Bond Concepts: Duration

The bonds will pay out their maturity value of $1000/bond regardless of current interest rates. So if I have a portfolio of 10 bonds each set to mature in exactly 14 months from today, then in 14 months I will receive 10,000 (plus final interest payments) regardless of the market rates. And the closer the bonds get to maturity, the closer the value comes to the $1000. I mean, how much could the price drop if it's going to pay out $1000 next week or next month?

I'll agree that it's possible to lose money in a very short term bond fund, but that would have to be the result of default - or a change in the duration of the fund's portfolio. I personally think that that risk is so small that I'd be okay with it. IMO the extra yield offsets that risk. (maybe 2-3% yield as opposed to .25% in a bank account)

And you'd have to be super careful that there are no commissions or fees to trade. Especially if you're doing multiple purchases. If you're not sure that there's $0 fees, you should just stick with the MM account. A few commissions would wipe out the whole advantage on an investment of a couple hundred dollars.

[Mr Nice Guy]

I would take a look at how much risk you are willing to take on. Are you willing to lose any or all of your principal investment?

Your time frame is pretty short IMO. Thus, I would go after some profitable investments. Emerging market funds can generate a higher ROI, but the downside is some of them can have a nice risk factor.

Final thought: Lets say you lose money in this. Maybe you wont be sippin Guiness in Dublin, but you got a great lesson in investing; something you can use for the rest of your life!

Good luck

[disneysteve]

So if I have a portfolio of 10 bonds each set to mature in exactly 14 months from today, then in 14 months I will receive 10,000 (plus final interest payments) regardless of the market rates.

I'll agree that it's possible to lose money in a very short term bond fund, but that would have to be the result of default - or a change in the duration of the fund's portfolio. I personally think that that risk is so small that I'd be okay with it. IMO the extra yield offsets that risk. (maybe 2-3% yield as opposed to .25% in a bank account)

Just so the OP is clear, there is a BIG difference between owning individual bonds and owning shares of a bond fund.

With individual bonds, the bond has a set maturity date. So you could buy a bond today that will mature 14 months from today. As long as you hold that bond until maturity (and the issuer doesn't default), you will get your full principal back plus earn interest along the way.

With a bond fund, there is no maturity date. There is an average maturity of the funds holdings which may consist of dozens or hundreds of bonds, but they mature at all different times and the fund may or may not hold them until they mature. They are constantly buying and selling bonds in the fund. That's what creates a level of risk that doesn't exist with the individual issues. Not to say that is good or bad but just make sure you understand what it is your are investing in.