This guest post was written by ABCs of Investing – a new site for novice investors which offers a weekly short and simple investing posts.
One of the most valuable pieces of money management information I‘ve learned is the concept of investment time horizon. The basic idea behind investment time horizon is that if you are investing for the long term (ie retirement and you are young) then you can consider having part or all of your investment in riskier securities such as equities or stocks. If you are investing for the short term (ie a house down payment) then you need to reduce your risk as much as possible and put the money into CDs or a high interest savings account.
All equities (stocks) are risky
While it is true that some stocks are safer than others – don't get the wrong idea that certain stocks (ie blue chip stocks) are safe investments. Yes, they are less risky than the junior mining stock the guy at the coffee shop told you about, but there is still a lot of risk in all kind of stocks – especially in the short term (think 2008 for example). This doesn't mean that you should avoid stocks because of risk – only that if you need the money in the near future – then stocks probably aren't the safest bet.
If the investment is composed mostly or entirely in equities then they are potentially more risky. Diversifying among more stocks reduces risk compared to a single stock but it's still a risky investment for the short term.
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Balanced or Target Date Investments
These types of investments can be misleading – there are no rules regarding what percentage of equities are in these , regardless of the name of the investment. It is up to the investor to do the research to find out what the mandate of the investment is (how they plan to invest your money) and hope that the portfolio managers stay on course. If you have your house down payment in a target date retirement investment that is coming due in the next few years i.e. target date 2015 – don't assume the equity component is small. The best thing is to put your money into an investment where you can be 100% confident of what you are investing in. CDs and high interest savings account are the best choice.
If you are investing for the short term then you need safety. If you are buying a house next year then go as safe as possible. The investment return doesn't matter – you need your money to be there when you need it.
If your time line is a bit longer – up to 5 years then I would still go very safe. If you know for sure it's 5 years then you have some options for locking in the money and getting a higher interest rate. No equities!!! this might be a situation where you are saving for something that you know you can't afford for a while….maybe a world travel trip or a cottage.
Keep it in a cash account – don't put it in any kind of retirement account such as 401k etc since you'll be looking at penalties if you withdraw while still young.
If you are investing for the long term then you should have part of your portfolio in equities. It doesn't have to be all or none – you can have 80% equities/20% bonds or 20% equities/80% bonds or any other combination you are comfortable with.
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* Please note: I had to change some of the text in the post to accommodate my compliance department. Just in case you thought some of the terms of the guest writer sound funny.
- The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
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- Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
- Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise and are subject to availability and change in price.