海角大神

Jane writes in:

I think you鈥檙e giving bad advice to people when you tell them not to put everything in stocks or real estate when making a long-term investment. Over a long period like ten years or more, you simply can鈥檛 beat the returns there.

Long-term investing relies on several assumptions, two of which hinge very strongly on personal luck and personal behavior.

One, you鈥檙e not going to touch that balance for a very long time. The chance that you鈥檒l touch that balance in any way over the next decade (at least) is very, very small. If there is a crisis in your life, you have other assets you can use to deal with that situation without touching your long-term investment.

Two, you are completely comfortable watching the balance of your investment drop through the floor every once in a while. It鈥檚 easy to feel good about an investment when you see it earn a 15% return over the course of a year. It鈥檚 a lot harder to feel good about it when you see a 40% drop over the course of a year.

The first issue can be resolved to a large extent through solid personal finance management. Pay off your debts, maintain an emergency fund, and you鈥檒l go a long way toward heading off most of the crises that would interfere with your long-term investing.

The second one, however, is a bit trickier to handle.

During 2008, I witnessed several people I know make panicked moves with regards to their retirement savings and their own personal investments. They yanked their money out of stocks in the latter days of 2008, locking in enormous losses, and put their money into other investments.

With hindsight, this looks like a terribly bad decision. 2009 and 2012 were both stellar years for the stock market and stocks have regained every bit of ground that they lost in those years.

The problem is that, in the moment, it鈥檚 very hard to see that type of rebound when you鈥檙e watching your life savings dwindle away. You also don鈥檛 necessarily know how you鈥檙e going to react in that moment.

My perspective is that the key to the matter is what I call a 鈥渉ardening鈥� of one鈥檚 needs. When you鈥檙e young and retirement is a very long way off, a big loss isn鈥檛 that big of a deal. I watched 2008 flow through my retirement accounts and it didn鈥檛 seem disastrous.

However, if I watched 2008 from the perspective of my parents or my in-laws, it鈥檚 a very different picture. It鈥檚 scary because it鈥檚 much more immediate. While they may have still been outside of that ten year timeframe, a big retirement loss is much more urgent because their lives are beginning to move toward retirement.

So, what I suggest is that if you鈥檝e reached a point where you know what your target 鈥渘umber鈥� is and you know roughly when you need to reach it, you need to start moving into safer investments, even if the horizon is more than ten years off. The 鈥渇irmer鈥� the target date and target number are, regardless of the time until you reach that point, the more you need to move into safer investments like bonds and cash.

What if you need those 鈥渂ig gains鈥� to reach your number? If that鈥檚 the case, then you need to look at saving more or else putting off your target date a little bit.

If you have a target date in mind and you鈥檙e gearing up your life to retire in that timeframe, a big stock market or real estate swoon becomes incredibly scary. Once that timeframe becomes pretty clear in your life, you鈥檙e making other life plans according to that timeline, and you see things progressing clearly toward that investment endpoint, you need to start preparing for it, even if it鈥檚 more than ten years out.

Don鈥檛 ride the giant roller coaster if you鈥檙e not in the right position to handle the big drops.

Again, personal finance isn鈥檛 about pure dollars and sense. It鈥檚 about managing your emotions, and it鈥檚 also about putting things in the broader context of your life. Keep that in mind with every single move you make.