I want to thank everyone for the many questions that have been coming in. This week's
topic of
choice is…investment time horizons.
Question #1: Scott, you indicated that those with "long-term time horizons"
should put a
significant portion of their funds in equities. First of all, what do you consider a
"long-term
time horizon"? Secondly, what do you suggest for those of us with just 4 to 5 years
left
before retirement?
Question #2: Over the past month, the market has concerned me. I want to stay the
course, but should I, if I want to retire in 2 years?
Before we get into time horizons, remember that when it comes to investing for retirement,
the most
important thing for you to do is to start a plan and stick with it. The type of plan you
have will
depend on your own situation, but the important thing is to remain consistent.
In general, a short time horizon is 0-5 years, a medium time horizon is 6-10 years, and a
long time
horizon is more than 10 years. I consider anything longer than 20 years or more as
infinite, since
there is no difference in terms of volatility between 20 years or 20 billion years. All
market cycles
we see are likely to be covered over a 20-year time period.
Short Time Horizon
The concern with a short time horizon is that it's very plausible that you could lose
money if you
invest it in stocks for five years or less. Note that I didn't say it was probable, but
that it's very
plausible. For example, people who invested in stocks in late 1972 didn't necessarily get
their
money back until 1977. We've had an unusual market in the '80s and '90s where that hasn't
happened, but during most 30-year time periods you'll find somebody who lost money in a
5-year
period.
What this means is that if you are going to retire in, say, 3 years, you should have no
more than 60%
to 70% of your money in equities, and you may want to have as little as 10% to 20%,
depending on
how much risk you can stomach.
Also, you have to look at your goals, and to what extent you will be able to revise them
suddenly if
the market takes a downturn. It's important to keep in mind that it's harder to make
adjustments to
your goals when you have a shorter time horizon. If you're planning to upgrade from a 1977
Dodge
Dart to a Yugo once you retire, but suddenly you can't afford to, you can probably revise
your
goals without too much trouble. However, if you've already gone out and bought a Rolls it
will be
harder to reverse course.
Intermediate Time Horizon
With an intermediate time period (6-10 years) it is very plausible that you would not lose
money in
the stock market. But that's not necessarily as good as it sounds. If you only break even
after 10
years, your purchasing power will be eaten away by inflation. One dollar 10 years from now
will not
buy the same as one dollar does today. So over the medium term you want to be sure your
return
will beat inflation.
What's more, particularly during times of very high inflation, the stock market tends to
go down.
Even fear of inflation can send the stock market down, as it did in 1994. Indeed, this
fear has
contributed to the volatility we've seen in recent months.
Long Time Horizon
If you have a longer time horizon (10 years and up), you have more time to plan around
what the
market does and to weather its inevitable ups and downs. If this is your time horizon, you
can
consider putting 100% of your long-term investments in stocks, if the potential
fluctuation won't
keep you up at night or lead you to panic sell when the market is down.
Other Factors to Consider
When thinking about how what percentage of money to invest in the stock market, it is also
important to look at what, specifically, you have your money in. Are we talking about
large-cap
stocks, small-cap stocks, or a balanced portfolio? How well have your funds performed
relative to
the market? These factors need to be taken into consideration.
If you truly need all of your money a year from now, I wouldn't advise putting any money
in stocks.
It just doesn't make sense. If you are investing for 4-5 years, depending on your risk
tolerance, I
might suggest putting 60% of the portfolio in equities, but I would go as low as 10% to
20% for an
anxious investor. From there I would decrease the percentage of equities each year, until
a year shy
of retirement you have no stocks in your portfolio.
Of course, this also depends on your risk level. Even investors with long-term time
horizons
shouldn't put 100% in equities if it makes them unable to sleep at night. The important
thing to do is
to "invest" some time in developing a plan, and then stick with it, no matter
what your time horizon.  Lummer's
Logic Archives
Scott L. Lummer, Ph.D., CFA, 401k Forum's Chief Investment
Officer, is a recognized expert in the investment field. He has conducted extensive
research on asset allocation, international investing, risk management, mutual fund
analysis, ethics and valuation, and is a co-author of The Pension Investment Handbook.
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