One of the first questions clients ask is how they should invest their money. I think they expect me to give them a secret recipe. There is so much noise in the media about how to invest that I can understand their frustration. The market is up, its down, hot stocks – it can be such a chore to make sense of it all.
My answer is straightforward. Investing boils down to one question: When will need the money you are investing? All the other decisions regarding risk tolerance, active management, asset allocation, security selection, fees, diversification, and tax minimization flow from that answer. When will you need your money?
You may be saving for a home down payment. You may need the money within the next six to 12 months. You cannot take any chance that your savings could decrease (or else you’d have to put off the home purchase). So investment of those funds would be very safe with little risk of principal loss.
You may be saving for retirement that is 30 years away. In that case, you may allow for more risk of principal in the expectation of greater gain. However, if retirement is only a few years away, then you may want to make sure several years of expenses are “in the bank.” But you also may want to take some more risk in retirement funds that won’t be needed for several years.
If your goal is to save for a child or grandchild’s college education then you may be willing to take on more risk/volatility if the child is young and the need for the money is a decade away. However, you may wish to have a different investment strategy if you expect to pay a tuition bill in the next 12 months.
In each case the time horizon for the money is the key point. In fact, you may have multiple investment strategies because you have several different financial goals and time horizons.
I want to point out the difference between investing and speculation. John Bogle, the founder of the Vanguard Group, has aptly named one of his recent books “The Clash of the Cultures: Investment vs. Speculation.” He explains how investing forecasts the earnings of an asset(s) over a certain period. Speculation, on the other hand, forecasts the timing or psychology of the market. As individual investors, it is much more difficult to speculate and earn a decent return. We are at the disadvantage of not having full information as other more sophisticated players, nor do we have the rapid trading platforms to truly time the market. Thus, my advice in the following blog entries will focus on long-term investing, not speculation.
So before turning to how to invest, take an inventory of your goals and your investment horizons – whether they are short-term (less than two years), medium-term (three to seven years), or long-term (over seven years). Put together a list of investment goals and their time horizons. Once you have your financial goals clarified, how to invest your hard-earned money becomes much easier.