Recommended allocation of $500k for three year time horizon is?

Your friend should stick with CDs or money market funds if they need to access the money in 3 yrs. There are countless ETFs that MIGHT outperform CD rates over the next 3 yrs, but they all come with a risk of capital loss. The higher the potential return, the higher the risk of capital loss. If this wasn't true, no one would invest in CDs until their rates increased to the point that is was true.

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My guideline is 10% equities per year.

Meaning if money is needed in 3 years (more than 36 months), a maximum exposure of 30% equities. At 24 months shift this to a maximum of 20% equities and at 1 year shift to a maximum of 10% equities.

I would keep remainder in cash based assets and bonds.

There is principal risk associated with this technique.

Another different idea is a moderate mutual fund, such as PRPFX, which is diversified enough to generally go up with returns greater than cash accounts (I expect a 6%+ return from it). It invests in gold, silver, growth stocks, swiss francs and US bonds and money markets.

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If capital preservation is the first goal, then market exposure is out of the question for a 3 year time frame. You need to be looking at something that is guaranteed. I'd be looking at brokered CDs and maybe a few of the highest rated corporate bonds if they are high enough to juice the returns a bit.

-john-

[I believe that John means *Stock* market exposure there][A] [And, I'd amend that with "highest rated *short-term* corporate bonds][B]

A) The stock market can (and has) lost bunches of money in the past which has taken several years to recover. It's easy to find a sizeable handful of 3-year periods over the last couple of decades where there were substantial losses. You have to go to *very* long periods to lower the historical chances of a loss. If capital preservation is important over a three year period, stocks are out.

B) while corporate bonds don't move precisely with treasuries, (the divergence is often discussed in terms of "spread" and changes in spread), they do respond to changes in interest rates. Just like treasury bonds, when interest rates go down, corporate bonds go up and vice-versa. The longer the term of the bond, the bigger the effect of those interest rate moves. One way to protect against potential capital losses in the face of interest rate moves is by having a shorter term (or even having the bond mature right when you're going to need the money and simply holding to term).

Note, of course, that unlike investing in treasuries (or FDIC guaranteed CDs) if you're going to invest in corporates, you need to take into account default risk and (or credit risk in the event of, say, a downgrade on a company you hold). One normally protects against issuer-specific risk like that via diversification - which can be a huge pain if you're trying to do this by holding individual bonds instead of a fund. The flip side is that a fund doesn't normally have a maturity date - so you can't buy a basket of bonds which mature just when you need the cash.

Nevertheless, a short-term investment grade corporate bond fund is very very unlikely to lose money over a three year period. A quick glance at one just now shows positive returns every single year over the last 7 and only two negative quarters (which were separated by over a year). Over the last 7 years (16 overlapping 3-year periods), the average 3-year return was about 4%/yr, the lowest was about 3%/yr and the highest was about 6%/yr.

< [snip...]

Depending on his tax bracket, muni's might be interesting. Perhaps something like VWSUX, Vanguard's Short Term Tax Exempt Fund. If he's in a state with income taxes, he might look at state specific funds.

The short term nature will limit changes in capital and muni's are particularly attractive right now.

-- Doug

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Preservation of capital on an after-tax, after-inflation basis is very difficult over a three-year period in the current environment. The February COI-U (urban) was 4% above February last year. Assuming a 25% tax rate, you would need a return of 5.33% in a taxable investment or, obviously, 4% in a tax-exempt muni. I'm not aware of any type of investment vehicle that will return that much over three years without significant risk. Some equity exposure probably would be required. Perhaps a portfolio with 20-30% equities, 40% bonds, and 30-40% cash has as good a shot as any at achieving it.

Dave

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Thanks. I decided to recommend VWSUX--they are in the highest tax bracket. Also thanks to breadwith for running the numbers on 3 yr intervals.

RL

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Oops. That was supposed to be CPI-U. Sorry.

Dave

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No problem. Wish I had more history handy.

Note with respect to VWSUX that up to 20% of the fund may be invested in securities which are subject to AMT.

Aside from that consideration, it's about as good as a short-term muni fund can be. Fantastic record, low expenses, top notch management.

Over the same period I looked at for corporates, this one has had only one single down quarter, and average returns on the order of 2-4% annualized. (no time to run the numbers the same way at the moment, sorry).

Hard to go wrong with that fund, again, aside from possible AMT considerations.

I don't know... It's got fairly high expenses and the net return is about the inflation rate. CD's seem to yield a better return. Or did I miss something?

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8 basis points? That's astoundingly low. Even the "investor" shares (with much lower minimums) have only 15bp expenses.

Yes, it is. Which, at the moment, for short-term capital preservation (ie. cash equivalents) is about all you can expect. Remember, the OP did *not* want to risk the money.

"tax exempt"