Investment instrument for investing money saved for a used car

This seems like over-planning. A car is just one of many things (though one of the larger things) you will presumably buy over the next few years, and you will hopefully be saving additional money over that time as well. A few percentage points of uncertainty about car price inflation seems lost in the noise.

Just keep a reasonable amount in a low-risk investment like high-yield savings, money market, or CD, and make the decision about how much to spend on which car when you're ready to buy. If you start seeing that you'll need to spend a little more than what you earmarked, spend less on other things to make up for it.

-Short answer: No. If your main concern is hedging against Used Car inflation over such a short time period your best option would be to buy the car now.

All of your other options are gambles (due to the short time frame and the potentially double digit inflation for Used Cars). You could hedge against Core inflation using an I-Bond or TIPS, but that won't come close to hedging against a positive Used Car inflation rate, and there are no safe or relatively safe Corporate bonds that come close to what you would need... even if you could figure that out (which you really can't).

However, you can track the inflation rate for Used Cars at either the FRED Database (St. Louis Fed) or the Bureau of Labor Statistics. The links I've given you go straight to Used Cars. This can help you adjust your savings as you go. You can do it on a monthly basis, if that is how granular you'd be willing to get. I wouldn't do it or recommend it, but that's an option. I think checking it annually is reasonable, though.

Used Cars' inflation rates have historically experienced far greater volatility than other categories of goods. This is why they were removed from the Core-CPI calculation in the mid 1990's. The only other things excluded from the calculation are Food & Energy, and for the same reason: Volatility.

For instance, year over year (March '20 - March '21) the rate was over 9%. However, the rate was negative almost the entire time between 2014 and September 2018 averaging between -(3)% - (4)%. That kind of compounding is significant, but can be undone very quickly and is, in any case, difficult to predict.

I hope you can see that this level of volatility precludes investing/hedging in the way you'd like.

Investments in equity securities whose time frame is <5 years are generally not advisable as they are closer to gambles than investments. I'd extend that to >10 years, actually. The longer, the better. Add to this reasonable forward return forecasts and you can see that you can't do what you'd like in this case unless you're willing to accept having 1/2 the money available when the time comes, instead. But, I assume that's not the case.

Congratulations. You have saved enough money now, to setup a needed purchase that won't take place for another 2 or three years, if there are no surprises.

Lets run some numbers. You have saved $20,000 and that would buy you a 3 year old make and model X. Your concern is that in 2 or 3 years the car price would have risen higher the measly interest would have increased your bank balance. Lets say it is 3 years, and prices rise 10% a year. That means the price will now be $26,620.

If you ignore the interest earned in savings account, that would mean you would have to set aside approximately $184 a month to make sure you kept the bank balance on track. Any interest you could get via a higher interest rate from a CD or higher yield savings account would reduce the monthly goal slightly.

What your savings has done for you can't be ignored. You now have the ability to get the car you want with very little additional funds required. That means that if your current car dies at an inconvenient time, you aren't scrambling to find a car, and find financing in a weekend. This money in the bank gives you the ability to negotiate a price without having to also negotiate a loan.

Nobody knows what cars will cost in 3 years. Are we at the peak today, or will they go through the roof? The last car we purchased was a new car. It was going to be a used car. We saved enough to not need a loan. When we went to look at cars we discovered that all the cars coming off their leases were the ones with all the bells and whistles. We weren't looking for most of those optional items. It turned out that the best prices were the new cars with the options we wanted.

I would slow the savings rate for the car to a trickle. Peek at the prices every 6 months or so. And sleep soundly that the amount I had saved would make the next car purchase a easier transaction.