Investing in stocks has been a great way to build wealth over time. The big challenge that investors face, though, stems from the fact that stock market returns are never guaranteed. From time to time, markets fall —as they did throughout much of the world in 2022.
That reality means that even if you can wind up with a great nest egg from your stock investments, you will probably want something other than stocks if you’re looking to spend that nest egg. Oh sure, if the market cooperates, you can always sell a stock after it has risen substantially. Since you can’t guarantee that it will rise, though, you have to either be okay with either not spending from your investments while you hope they recover or keeping the money you need to spend soon somewhere safer.
Three timeframes to think about
It’s helpful to think about your money in terms of when you expect to need to spend it. The first — and shortest — window is money you’re not sure when you’ll need, but which you might need to spend at any time, such as in an emergency. That money should be kept in cash, in something like an insured bank account.
Yes, money in the bank is exposed to inflation. That’s why an emergency fund should just cover somewhere in the neighborhood of three-to-six months’ worth of your anticipated expenses. It’s enough so that if you need it, you’ll be glad you have it, but not so much that you put your long-term future at risk due to not having enough invested with growth potential.
The second time frame to consider is money you know you will need to spend within the next five years.
Instead of just holding that in cash, you can instead consider keeping it in Certificates of Deposits or investment-grade bonds that are scheduled to mature just before you need to spend it.
Bonds are typically sold with a face value. The face value of bonds can differ from one country to another. This includes coupon interest rate - a fixed rate of interest that the bond issuer agrees to pay to the bondholder periodically over the life of the bond. During the time period, you own the bond, you can expect to get that declared interest on a regular date.
Finally, the third time period to consider is money you expect to spend more than five years from now. That time period is far enough in the future that it may be worth the additional risks and volatility to invest your money in stocks. The theory there is that the market may be volatile in the short run, but the longer your time period, the higher your chances are of seeing a positive return. Five years doesn’t guarantee you’ll make money, but it gives you a good shot.
In addition, if the stock market stays rough for an extended period of time, having that five-year buffer of bonds from that second time period gives you time to adjust. In an extended downturn, you can try to cut back spending, seek out another source of money, or attempt to push back the timing of those longer-term expenses.
What does that mean in terms of percentages?
This time-based way of thinking about how you should consider allocating your money is a bit different than typical guidance that focuses on percentages. Those typical guides vary from “120 minus your age” as the percentage you should hold in stocks vs. bonds to a “60% stocks, 40% bonds” balanced allocation.
The big benefit of thinking about your allocation in terms of time is that it helps you better match your portfolio to what you’re looking to use your money for. When you instead force yourself to a specific percentage allocation, it doesn’t help all that much in markets like the one we faced in 2022. When both stocks and longer-term bonds drop because inflation and higher interest rates spook investors, it gets very hard to know where to withdraw from within those percentage-focused portfolios.
If you need money to spend from your portfolio, not having a good place to withdraw from can be a fairly big problem. By setting yourself up with a time-focused approach, you’ll give yourself a pretty good shot of having the cash you need, when you need it. When all is said and done, after all, isn’t that what we’re all investing for?
At the time of publication, Chuck Saletta did not own shares of any stock mentioned in this article.
Sources – EasyResearch, Tipranks, Nasdaq, Avast, Arstechinca, Intel, INTC, Digital Trends, Fuse, Waferworld, WCC Tech, XDA, Pure Storage, Tech Radar
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