Stockpiling for the Short Term

Question of the week:I just got my first real job and I'm starting to save big time. I want to buy a new car within the next year, have enough for a down payment on a house in five years and save for retirement! Right now this money is just sitting in a savings account earning dismal interest. Are there better choices? --Blaine

Dear Blaine,

Congratulations on your ambitious savings goals. Now you just need to get that money in the right places, and you do have options beyond the very popular savings account.

The main thing that will help you decide where to put your money is how much time you have before needing that money. Split your goals into either short term--everything you will need (or might need, like for an emergency), in the next five years--or long term, everything more than five years out.

I believe that most money set aside for long-term goals, like retirement, should be in vehicles that will significantly grow your capital over time, like stocks or stock funds. (For me, this five-year line is what distinguishes "savings" from "investments.")

As for short-term savings, we recently asked Armchair Millionaire community members where they're keeping their money. Here's a sampling of what we heard:

"My main short-term goal is to have six months worth of living expenses in a very liquid account. I use a money market account since the interest rate is a little higher." --Bryan J.

"My short-term goal is to have enough money for a car. I keep this cash in an Internet savings account that pays 3 percent interest." --Miller

"We're saving for the short-term for travel and house renovation and medium-term for a replacement car and rainy day fund. These savings are in CDs and savings accounts." --Simplicity

For your short-term goals, you want your money safe and liquid so you can easily access it when you need it. My checklist has your major choices, with the pros and cons for each.

The Armchair Millionaire's Checklist for Stockpiling Your Savings

• Certificates of deposit. CDs are issued by banks, savings and loans and credit unions and are federally guaranteed. When you buy a CD, you commit to leaving the money untouched for a fixed amount of time (anywhere from 30 days to five years or more). The longer the term, the higher interest rate, but if you withdraw your money early, you'll pay a penalty.

• Money market deposit accounts. Federally guaranteed and available from banks, credit unions and S&Ls, these accounts are much like regular checking accounts, but pay a bit of interest. They typically limit the number of checks you can write each month, so a money market account probably can't take the place of your checking account. Accounts paying higher interest may require a high minimum balance.

• Money market funds. These are a type of mutual fund and are available from fund companies and brokerages. They invest in high-quality, short-term debt instruments, so while they're not federally guaranteed, they are very safe. They offer check writing, usually with fewer restrictions than money market deposit accounts.

• I bonds. These are a nifty kind of savings bond offered by the U.S. Treasury with an interest rate adjusted periodically to keep up with inflation. Interest is exempt from state and local taxes, but you'll pay a small penalty if you redeem one before owning it for five years. I bonds are available from banks or directly from Uncle Sam at www.treasurydirect.gov.

• Bond mutual funds. These funds purchase government bonds, municipal bonds, corporate bonds or some combination of the three. They're convenient and give you instant diversification with a lot of different bonds, but they carry no guarantees. Different funds carry different levels of risk, and not all are appropriate for short-term savings, so look closely before buying.

THE BOTTOM LINE: The more security and liquidity you need for your savings, the lower the interest rate you'll have to accept. But when you balance this out with the rewards of long-term investing, you'll have the best of all worlds.

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