Know Your Investing Timeline
At the end of January, coronavirus news sent the markets into a tumble. But last week's collapse made the January slump look like small potatoes. Historic market drops remind us that markets are volatile and unpredictable. Bear markets and recessions happen. And unfortunately, there's no way to predict exactly when they will happen, how bad they'll be, or how long they'll last. That's why you should protect any funds that you expect to use in the next 5 years from risk.
You'll want to avoid investing that amount in stocks or anything else that could tank in the next recession, market crash, etc. So this month I'm writing about the importance of knowing your own investing timeline. It's a helpful defense against that sinking feeling you might have in your stomach during times like this. I love my house, but we don't have enough closet space. Most of our closets are filled with giant tubs of things we're not currently using. Holiday decorations, hand-me-downs that the girls haven't grown into yet, mementos, you name it. Our bedroom closets are small. When we remodeled our house, we opted for more room in the common areas and less room everywhere else. I make it work by keeping my closet seasonal. When I open the doors, I only see items that I'm going to wear that season. If I'm not going to wear it soon, it goes in a tub, up on a shelf, out of the way. If there's a chance that I am going to need a certain item, I keep it where I can easily get it.
Your portfolio needs to work the same way. The end goal for most investors is retirement. As I've often written, most investors need to target a higher rate-of-return in order retire comfortably. This means embracing risk in long term investments. I'm a big believer in stocks, while some prefer real estate or other investments. It all depends on what you're comfortable with. You'll rely on these long term investments to create the wealth you need to retire. But their value will probably rise and fall a lot between now and then. For these long term, high growth investments, you should only invest in funds you will not need anytime soon. You don't want to be forced to pull money out at the wrong time, when prices are falling.
This is why you need to create an investing timeline and allocate your portfolio accordingly. Here's what I tell my clients:
Identify the major expenditures you know or strongly suspect you'll be making in the next 5 years.
Put the money for those expenditures where it will be accessible when you need it. Your options are cash, bonds or CDs that mature on a coordinated schedule so you avoid paying early withdrawal penalties.
The reason for the 5-year time frame is simple. No one knows when the next bear market, recession or market collapse will happen. And when those events do happen, no one knows how long the markets will take to recover. But history suggests that 5 years is probably enough time for markets to recover from even the worst crashes. These funds won't grow when the bulls are running but they won't evaporate when the markets fall, either. Your money will be there, predictably, when you need it. There is no consensus on how bad the human toll or financial cost of the coronavirus will ultimately be. There is no consensus on when the markets will return to their historic peaks of just a few weeks ago. So know your timeline, stay diversified, and keep riding it out.