I’m saving for a house. Should I invest my money?

My daughter has about $150,000 she would like to invest for about two years, after which she plans to buy a house. Can you recommend any dividend stocks she can invest in?

Whether you're saving for a house, a university education or any other large expenditure, the general rule of thumb is that you shouldn't invest money if you'll need to spend it in the next five years. In such circumstances, the priority should be keeping your principal safe.

The rationale is simple: Over the long term, the stock market has produced annualized total returns in the high single digits, which is why stocks are your best bet if you plan to put your money away for many years.

However, over shorter periods, stock-market returns are highly variable. In the past 20 years, for example, the S&P/TSX composite index posted a compound annualized total return of about 7.3 per cent. But in six of those years, the index suffered a loss – the most severe being a 35-per-cent drop in 2008.

If your daughter invests her money now and the market goes for a belly-flop in the next year or two, she could find herself having to cash out to buy a home when her portfolio is down 10 per cent or 20 per cent, meaning she'd have $15,000 or $30,000 less for a down payment.

So what should she do with her cash?

For maximum flexibility and safety, the best option is a high-interest savings account. Interest rates at some of the better-known financial institutions aren't great; Tangerine and PC Financial, for example, currently pay 0.8 per cent (Tangerine offers a higher rate for the first six months to new customers). But several smaller banks and credit unions offer high-interest savings rates from 1.5 per cent to 2 per cent. (Ratehub.ca is a good place to compare rates.)

Your daughter could do slightly better than that by locking her money into a guaranteed investment certificate for one or two years. But this is probably not advisable; if the house of her dreams comes along 18 months from now but she can't access her money until six months after that, a fraction of a point in incremental interest won't have been worth it.

Whatever financial institution she chooses, she should be sure to ask about deposit insurance and structure her savings so that all of her money is covered in the unlikely event that the financial institution fails. Banks and trust companies are typically covered by the Canada Deposit Insurance Corp., whereas credit unions are usually protected by a provincial deposit insurer.

Depending on the insurer and type of account, there may be limits on the size of the deposit covered. CDIC, for example, covers deposits up to $100,000 at member financial institutions. So, instead of putting the entire $150,000 into one savings account at a CDIC member firm, she should consider spreading it across two institutions – or two different insured account categories at the same institution – so her money is fully insured. (More information is available at cdic.ca).

The Deposit Insurance Corp. of Ontario (dico.com), on the other hand, has a $100,000 insured limit on non-registered deposits, but no maximum amount for registered accounts such as registered retirement savings plans, tax-free savings accounts and registered education savings plans. The Deposit Guarantee Corp. of Manitoba (depositguarantee.mb.ca) provides unlimited coverage regardless of whether the account is registered or non-registered.

Keep in mind that the five-year rule of thumb is not carved in stone; it's just a guideline designed to manage risk. Some people with shorter time horizons might feel comfortable investing in stocks and accepting the potential for losses, while others with longer horizons for a big purchase might still want to minimize their exposure to equities. Also remember that risk cuts both ways; if your daughter puts her money into a savings account earning 1 per cent, the stock market could rise 10 or 20 per cent over the next couple of years.

But while there is a high probability – based on history – that the stock market will rise over the long term, it's impossible to predict what path the market will take in the short term. That's why playing it safe with money that will be needed for a big purchase in the next couple of years is usually the best course of action.