What Defines Long Term Investing?

What Defines Long Term Investing?

How long is long term? 

What Defines Long-Term Investing?

How long is long term?
  To us long-term investing implies at least five years. I will attempt to explain why I have chosen that seemingly arbitrary number and what you might consider doing with cash you need in less than five years.

The primary reasons for a major withdrawal from your investment account are major expenditures like paying for your kids’ education or the purchase of a car or house. When it comes to these major commitments you can usually ill afford to take any risk. In other words, if you have already saved enough to make a down payment on a condo then the opportunity to earn an extra 10% while you wait is not worth the risk it might decline by 10%. Nothing should get in the way of making that down payment.

Invest In Something Safe If You Really Need It

Let me illustrate with some example. If you look at the graphical portfolio performance projection below, you’ll see that a Moderate Growth (70% equities) portfolio has a 36% probability of loss after one year:



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After five years the probability of loss drops to 20%:



(Click to enlarge)

After 10 years the probability of loss reduces to 12%:



(Click to enlarge)

As you can see from the table below the probability of loss essentially flattens out after approximately seven years:



(Click to enlarge)

The risk that even a well-diversified portfolio declines in the short term is very high. However, it becomes far more tolerable after five years. Therefore, taking some risk to get some extra return could prove worthwhile if you’re not going to make a major expenditure until a number of years in the future.

 Consider Other Options for Big Purchases in the Short Term

We recommend investing your money in a very low-risk instrument like a money market account, savings account or certificate of deposit if you need to make a big purchase in the short term.

We also don’t think a diversified portfolio of index funds is the proper vehicle for your emergency fund. We think you should stash away at least three to six months of your living expenses in a money market account before you even begin to think about investing.

We are often asked if CDs or money market accounts make sense in a very low-interest-rate environment such as the one we face today. The question arises because many people wonder why they should keep their money in an account that generates a return below the rate of inflation — and well below an equity oriented portfolio. Over the short term the lost purchasing power due to earning less than the rate of inflation will not hurt you nearly as much as the volatility associated with an equity oriented diversified portfolio potentially killing your ability to make your big purchase.

What to Do When Markets Are Volatile
TWM Diversification Process

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