Okay, you have just three years and a hundred thousand dollars burning a hole in your pocket. Three measly years and you need to know where to invest that money so that, in three years when you need that investment, you know that you have not risked that money for the sake of return. Where do you invest it? What type of mutual funds, including ETF’s meet this requirement?

Three years as a time horizon is a tricky one. It is neither short-term nor long-term. Some may call it medium-term, but when you have just three asset classes from which to choose – cash, income, equities – how to do you find that best 3-year time horizon. Because let’s face it; based on the interest rate environment, many bond funds now have a 5-year time requirement. And high yield investments, due largely to their speculative nature really should be longer-term, even if they come with the probability today that they will benefit from rates in the next 12-36 months.

Based on the interest rate environment, many bond funds now have a 5-year time requirement…

And equity funds, well, even the most conservative come with a minimum time investment of 5 years. Anything short of that is just far too risky for the investor. Of course, luck can always prevail and provide the right return after just 3 years, but there is no guarantee of that. Suppose you invested in 2005… three years later would put you into 2008, arguably one of the worst years for the markets. You would have been (censored), kicking yourself.

Okay, and let’s say you invested in bonds at the same time. Short of a government bond fund that saw rates plummet while the US borrowed heavily and saw some rates so close to zero that brokers quoted them that way, you would have also been (censored), kicking yourself for ever thinking that bond funds were the safest and greatest thing since, well, sliced bread.

In 2005, the best 3-year investment would have been a 3-year term deposit… with a financial institution that did not go under. But remember, even people who invested in Citibank were nervous in 2007/2008, lining up to get access to their money. Remember that panic?

But that was the past, right? Today, things are different. Citi is still around, rates are at their lowest and some of the best performing mutual funds in 2009 were indeed bond and equity funds. It makes high yield investments look really lucrative right, especially after this very site announced that its top pick for 2010 was a high yield investment fund. But even the most aggressive financial planner would recommend a 5-year time horizon on a fund like that!

So what are your options when it comes to a 3-year maximum time horizon?

Cash Equivalent

You could look at a cash equivalent fund, but kiss any kind of return goodbye.

You could also look at a term deposit but consider than rates are likely to increase, so if you lock up your money, you will lose purchasing power.

Bond Funds

While bond funds will present marginally more risk, your short-term bond funds will allow fairly decent turnover within the fund, mitigating the risk of holding longer term funds. While rates of return will not come close to those expected in some of the riskier funds, the idea here is to get back what you invest.

Diversify

Perhaps your best bet with your $100,000 and 3-years, would be to diversify your holdings. This might look like 30% short-term bond funds, 30% cash equivalent or Treasuries, 25% Cash, and 15% term deposit. The strategy might involve using the cash and cash equivalent funds to gradually increase your short-term bond holdings or term deposit holdings based on the performance over the next 2 years so that at the end of 2 years, your portfolio might have 65% short-term bonds and 35% term deposits that mature in the year that you need the funds.

A riskier investor might be able to absorb the potential volatility and impact that a lower-risk equity fund can offer, but most financial planners will not even touch that one… leaving you to make your trades with a discount broker.

At any rate, realize that with 3 years your investment options will be limited. And while growth and returns will be low, your objective should be to virtually guarantee return of capital. Even the most educated fund manager would subscribe to such a strategy, ensuring that investment risk is only so high as the expected rate of return.

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