Believe it or not, a prime determinant of whether or not you should be investing in the stock market, may be the amount of time you are planning to have the money invested. Or a better way to say that may be: when do you need your money back?
On one end of the spectrum are the investors who have very long time horizons. By which we mean decades or even centuries. For example, the Harvard endowment is around 400 years old; Oxford’s is even older than that. These investors buy stocks because over such long periods the markets tend to track the general success of the overall economy. As economic productivity accumulates over the years, it pushes stock prices higher. This certainly doesn’t happen in a straight line, but for these ultra long-term investors (in fact most college endowments make the assumption that they are investing in perpetuity: that the mission of the endowment and the institution will never come to an end), there is a built in ability to wait out the periodic ups and downs and harvest the full benefit of the eventual net move. For these investors, an allocation of stock holdings is probably quite reasonable, and the evidence is that most endowment managers think so too, given the frequency with which they deploy capital in this way.
On the opposite end of the spectrum are those who use the shorter term moves of the market to participate in the age-old adage of buy low/sell high. These investors might hop in for a year or two after a major meltdown seems to have run its course (think: entry points in 2003, and again in 2009). Then again, we could be talking about those who consider an hour a long time to hold something. Either way, the hallmark of these investors is that they feel that they know when the market has run too far in one direction, and that the chances of it snapping back are greater than the chances of it continuing to move past the fundamentals.
This type of thing is hard to do in practice, because it is very easy to outsmart yourself and zig when you should be zagging. But that said, history has provided us with a list of folks who have successfully followed these methods for a period of time, and in so doing built themselves both a large account balance and a large reputation. There are also legions of smaller traders whom you’ve never heard of, who nonetheless succeed more than they fail, and make a decent living off temporary price changes.
In reality, it actually is much easier to get a sense of what the market will probably do in the next week than what it will probably do over the next six months. As a result, those who know how to read the data and have the discipline to take the necessary steps can do quite well moving in and out of the markets over relatively short periods of time.
So the long-term can make it work and the short–term can (sometimes) make it work. The reasons are very different, but the result in both cases has a good shot at being positive.
Which type of investor has less of a shot? Interestingly, those standing right in the middle: the medium-term investor.
Why? Well essentially because such an investor has neither of the strengths that the other two are bringing to the table. Someone who is looking to put their money in and not jump right back out is less likely to try to read the tea leaves and time their opening buy. But if they don’t have the ability to hold the investment a decade (or even a generation) while waiting out a severe bear market, they might get caught having to sell at less than what they originally paid. That means a 0% return for the entire holding period, plus a loss on the exit.
As a rule of thumb, we question the wisdom of investing in the stock market when an investor can’t comfortably wait out a 5 to 10 year downturn/recovery cycle if they have to. If it’s possible that they will need to liquidate some of their savings during that period in order to pay for living expenses or emergencies, then the risk that they face from being a stock investor is proportionally greater than those other types of investors we mentioned.
Think about it like this: if you start with $100K which falls to $60K, and you have to pull the money out to pay for something unexpected (like a year of nursing home fees), then the expense effectively costs you $100K, not $60K. You had to book the loss, and there’s no capital left to participate in a future recovery. If the money had originally been in something else which didn’t lose value, then there would still be $40K left over.
So strict adherence to the 5-to-10-year requirement is going to effectively take most retires out of the picture as stock investors. If you no longer have income from a job, it is very hard to state definitively that you won’t have to touch your savings at any time in the next decade.
This fact is really the base impetus for this entire site. Because if you decide you shouldn’t invest in the most ubiquitous asset class in this country, your probable next question is going to be, “What are my other choices.” That’s what the content on this site aims to discuss.