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I'm 27 and I have a Roth IRA and a savings account. I plan to save for my retirement, but within the next two years I also plan to buy a home. What investments should I be making to prepare for both short- and long-term goals?
—Tommy, San Francisco
Your challenge is that you have two goals that require two diametrically opposed investing strategies.
To achieve your long-term goal of retirement, you want to focus on investments that can grow at a much faster pace than inflation, and you don't have to worry about occasional setbacks. (Even the doozy of a bear we've had over the past three years will seem only a blip when you're looking back some 38 years from now.)
So that means you want to stock your Roth IRA mostly with stocks or stock mutual funds (and aggressive ones at that). You're looking for high returns to take full advantage of that tax-free compounding that the Roth offers. You can identify stock funds with respectable track records and reasonable fees by going to our Fund Screener.
As for the house...
Buying a house within two years requires the exact opposite approach. You should be concerned with the possibility of short-term setbacks. The last thing you want is to have money sitting in a stock fund that plummets a couple of weeks before closing.
I mean, just think what would have happened if someone in 1999 decided to invest his house fund worth, say, $20,000, in tech-stock funds. Two years later that twenty grand would have been worth around $8,400. In short, that person would have had to come up with lots of cash elsewhere, taken out a larger loan or settled for a more modest house.
So the house money has to go in cash equivalents: money market funds or short-term CDs. Unfortunately, the returns on these options are pretty paltry right now.
One-year CDs are averaging yields of 1.4 percent and 1.6 percent, respectively, although you can probably find higher-yielding ones by checking out our Rate Watch screen. Money funds, meanwhile, are yielding less than 1 percent on average, although, again, you can do better by checking out the iMoneyNet site.
You might be able to grab a bit more yield going to an ultrashort bond fund -- that is, a bond fund with an average maturity of less than a year. But you probably want to stay away from anything with a maturity much longer than that. Any extra yield you might earn in longer-term alternatives could disappear if interest rates rise and eat into the principal value of the fund. You can screen for ultrashort bond funds by using Morningstar's Fund Selector tool.
Bring it all together
But there's another issue you've got to deal with: Can you save adequately for both of these goals simultaneously, or should you reach your short-term goal first and then save for retirement? The answer, of course, depends on how good a saver you are, and how big a downpayment you're trying to accumulate.
This year and next, the maximum contribution to a Roth is $3,000. So perhaps you want to see how much you would still be able to save after sticking three grand in a Roth, and then calculate whether you'll have enough to accumulate the down payment wad you need. If it appears you're going to be short, you can always cut back on the Roth a bit and devote more to the house.
Now, you do have the option of tapping the Roth if you need more money for your downpayment fund. Any contributions you make to the Roth can be pulled out at any time without tax or penalty. (The rules are slightly different if you rolled contributions from a traditional IRA into a Roth. If you fall into that category, click here.)
Just remember, though: If you've invested your Roth stash in stocks or stock funds and the market hits a rough spot, you may not have as much available as you expected. So if you really, really want that house in two years, I recommend you focus on that goal first. You'll still have plenty of time to invest for retirement.
Walter Updegrave is a senior editor at MONEY Magazine and is the author of "Investing for the Financially Challenged." He can be seen regularly Monday mornings at 7:40 am on CNNfn.