So you want to make a big purchase. How do you save for it?

Most people’s monthly spending is a series of recurring payments, like rent, food, and utilities. There are also some one-time purchases that might require a few months of saving, like a nice vacation or a new suit.

And then there are some things that require many months or years of savings.

An engagement ring. A wedding. A new car. A down payment on a house.

When saving for big purchases, how do you go about saving the money, and how should you invest those savings before you buy?

Saving for a big purchase

Many people like to have a separate account for their big purchase. They might have a regular savings account, but then create a separate savings account that might be called “Wedding” or “Down Payment.” This separates the money that is being saved for your big purchase from your other savings. By segregating this account from the others, you are able to adjust the rest of your spending to help you save for this big purchase.

In general, it’s best to save a fixed amount of money each month over time. For example, if you want to save $80,000 for a down payment on a house, you might choose to save $4,000/month for 20 months. Ideally, you would automate this saving by having $4,000 of your paycheck go to the “Down Payment” account, and the rest of your money goes to your checking account.

Should you invest your savings?

A very common question among physicians and other investors is what to do with the money as you are saving it, but before you actually buy the big purchase. Before you buy that new house, tens of thousands of dollars may be sitting around in a savings account collecting 0.01% interest. You could put it in relatively low-risk bonds, but bonds can lose value. Similarly, if you invest the money in the stock market, you could lose a significant amount of your savings if the stock market falls.

The all-cash method

Because there is no uncertainty in the value of the account, the all-cash method helps you know precisely when you will have enough money to make your big purchase. The all-cash method is best if you have a deadline. For example, if you are saving for a wedding or engagement ring, then it would probably be best to keep your money in cash, because you don’t want to be pushing back your wedding date or when you can pop the question.

The downside of the all-cash method is the very low-interest rates in savings accounts or CDs. After the financial crisis, the Federal Reserve cut interest rates so much that you could hardly earn any interest on money from a savings account. However, as the Federal Reserve has been slowly increasing interest rates, so have the banks.

Ally savings accounts currently pay 1.25% and 1-year CDs pay 1.5%. I fully expect that number to rise as the Federal Reserve continues to raise rates. Online banks were offering 3-4% interest rates for CDs prior to the financial crisis, so you can make a decent return in safe investments during a normal interest rate environment.

The bonds method

Some people don’t want to take the risk of buying stock with their savings, but they still want to be getting some investment return on their savings. Bonds serve as a reasonable middle ground for many savers.

The problem with bonds is that they are not a risk-free investment. Often times, bonds do go down, and remember that the stated yield on a bond does not equal its return. Even if you were to buy a Treasury bond fund, if the yields on Treasuries rise, then their prices would go down, and you could actually lose money, even though the U.S. Treasury is assumed to have zero chance of default.

However, the expected returns on bonds will be higher than that of CDs or cash, and the swings will probably not be so significant for you to lose sleep at night. It is a reasonable middle-ground between putting all your money in cash and investing it in the stock market.

The stocks method

The most aggressive method is to simply invest it in the stock market. This is best if you don’t have a set deadline to purchase the big-ticket item. If the stock market falls significantly while you are saving, then the only thing that happens is that your purchase is delayed and you have to save longer for the purchase.

For example, if you are saving a down payment for a house, if the stock market falls, you may have to delay your purchase of a new home by a year. Since you’re continually saving, you’ll still eventually be able to buy the house, and maybe the house will be cheaper because the real estate and stock market are correlated.

And don’t forget, if the stock market goes up (which occurs more often that it going down), then you’ll be able to save less and potentially make your purchase earlier than expected.

The stocks method

When saving for a big purchase, create a separate account so that the money can be segregated from your other accounts.

There is no right way to invest your savings, but if the date of your big purchase is fixed, such as your wedding day, then you should probably keep it all in cash. If the purchase date can be easily pushed back, such as purchasing a house, then consider investing your savings in the stock market to maximize your returns. For a middle ground, consider investing your money in bonds, or a combination of cash, bonds, and stocks.

What do you think? How did you save for the big purchases in life? Did you invest the money in the stock market, the bond market, or CDs/cash?

“Wall Street Physician,” a former Wall Street derivatives trader , is a physician who blogs at his self-titled site, the Wall Street Physician.

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