How Much Time Is on Your Horizon?

By Scott Lummer
Chief Investment Officer, mPower

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.

Scott L. Lummer, Ph.D., CFA, mPower'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. He wants to know what's on your mind, so feel free to send him your questions about the stock market! He'll answer as many as he can in his weekly column.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

How Much Time Is on Your Horizon?

By Scott Lummer
Chief Investment Officer, mPower

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.

Scott L. Lummer, Ph.D., CFA, mPower'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. He wants to know what's on your mind, so feel free to send him your questions about the stock market! He'll answer as many as he can in his weekly column.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.