Risk and Return
When do you need the money?
Typically goals are broken down to short-term goals of two years or less, intermediate-term goals between three and nine years, and long-term time horizons which could be 10 years or even decades.
If you are investing for a short-term goal or intermediate-term goal, you want to limit the risk that you will lose money.
For example, if you are investing money to go back to school in two years, you can not afford the money you invest to decrease in value since it may not have time to grow. If you lose money in this situation, you may not be able to go attain your desired goal of going back to school.
Short and intermediate-term goals require investments that offer both predictability and stability. These investments would have a “sleep good at night” quality to them, meaning you will not lose any sleep worrying about your investments doing badly.
Look at the pyramid diagram (below) showing high risk and low risk investment options. For short-term and intermediate-term goals, one should be invested in the “base” options.
If you are investing for a long-term goal, such as planning for your retirement in 30-40 years, your main objective is to see this money grow. Long-term investors are able to take on more risk because they plan to be invested for such a long period of time that short-term swings in the stock market will not impact them. In the pyramid diagram (above), one would be invested in the “middle” options.
Let’s break down these two examples of shorter-term goals and longer-term goals one last time. If you are 24 years old and plan on retiring in 40 years at age 64, why should you lose sleep if the stock market is doing poorly for a few years? Time is on your side; over the long run stocks have tended to outperform other investments. You are investing for 40 years so if you have a few bad years but mostly good years, you will be ahead. The opposite is true for short-term and intermediate-term goals. If you would invest as aggressively for a vacation you would like to take a year from now as you do for your retirement, you may lose a large portion of that money because you will only be investing for 12 months, not many years. Keep in mind, the stock market is risky, but with a longer time horizon, we help reduce that risk.
The investment options in the “summit” portion of the pyramid diagram which includes options, futures, and collectables, are not investments for the average investor; they tend to be used more strategically and can require a lot of money. Do not look at the summit as an end goal; most people have no reason to venture into these choices and can achieve their goals through the “middle” options.