John writes in with a question about parking medium to long-term savings for a car replacement fund.
Here’s my situation: my car is 7 years-old with only 60,000 miles on it. It’s in good condition and definitely dependable; I plan on using it for another 5-10 years (five being the least). I figure that after 7 years of saving I would have about $8,400 plus the trade in value for my car – we’ll say that’s $1,000 for a total of $9,400.
My question is what do to with those savings? I don’t want to just let them sit there in my savings account, although it does have a decent APY of 1.40%. Should I put a sizable chuck into a 5 year CD and then continue to ladder it in CDs of decreasing term lengths until I need the money to buy my car? Or should I just put it in a money market account, or higher yield savings account?
I want to maximize the money earned on that fund with out totally sacrificing my ability to withdraw it should an emergency come up, or I need to buy a new car sooner. What would you recommend?
John also shared with me that he is nearly debt free and will begin this car replacement fund after building a small emergency fund. Normally, I would recommend investing money that is to be used greater than five years out in a mix of fairly conservative mutual funds, such as a broad index fund with a low-fee brokerage like Vanguard.
However, this case is a little different because John is dedicating these funds as a car replacement fund. As such, the need to use these funds could arise any time between now and the six or seven years he plans to save. My own experience with Murphy’s Law leads me to believe John’s car will die the exact moment there is a market downturn, causing John to pull out savings at precisely the wrong time.
Instead of dabbling in a risky market, I would suggest parking the savings in an online savings account or money market account, and possibly a CD. I’m hesitant to fully recommend a CD because John mentions the possibility of tapping the funds in an emergency. To do so, he’d have to pay a penalty for cashing out the CD before the term expires.
Sometimes we have to sacrifice a little earnings for peace of mind, and I think this is the case with John’s car replacement fund. I’ve taken the same approach with my own set of sinking funds and targeted savings accounts. For now, they are stashed away in an online savings account at ING Direct.
Funds I don’t plan to use for a number of years will soon be laddered in CDs to increase the rate of return slightly. I’m comfortable reserving market investments for long-term saving goals.
Do you have any additional advice for John? Where are you currently parking savings for large purchases?