I enjoy writing about investing. Over the years, I have found that most people are focused on returns. The higher the better, and if your return wasn’t as high as mine, you didn’t invest as well as you could have or should have. But there is a flaw in this type of thinking. A bigger return isn’t always better for everyone.
Let’s look at an example. We have Kevin, a 30 year old saving for retirement. He invests in an 80% stock / 20% bond portfolio, which has earned him 9% annually. We also have Mike, a 27 year old saving for a new car in three years. He is invested in a CD ladder (multiple bank CD’s with varying maturities and interest rates), that has earned him 3.5% annually.
Without knowing the details of their goals, if I were to tell you that Kevin earned 9% on his money and Mike earned 3.5% on his money, you would think that Kevin is the winner. He is earning much more than Mike. But really, they are both winners. Kevin is earning a good return of 9% for his goal of retirement in 30-plus years. Since his goal is long term, he is able to afford more risk, thus earning him a higher return.
Mike is also earning a good return. Since his goal is short term, he is taking much less risk and as a result, earns a lower return. But just because his return is lower doesn’t mean it’s bad.
Instead of focusing on returns, focus on your goal and whether or not the return you earn on the risk you are taking with your money is enough. Just because you “only” earned 5% doesn’t mean that you did great or poorly in an overall sense. How you did depends solely on what you goal is. Focus first on what your goal is, then focus on what kind of return you can expect for the time-frame you have of achieving your goal. Once you have a baseline on what you can expect to return, you can then determine if your return really was bad or good.
Some typical guidelines for your returns are as follows:
- Long Term Investing (10 years or longer): 8% or more
- Intermediate Term Investing (6 to 9 years): 5%
- Short Term Investing (1 to 5 years): 3%
How to invest for those time frames:
- For long term investing, you should focus on stocks with an increasing mix of bonds as you approach your goal.
- For intermediate term investing, you should be mainly in short term bonds and bank CD’s (cd rates vary depending on the market, but this is a safe investment regardless of the time), with a small amount of stocks sprinkled in. Ideally, you would keep the stock portion to 20% or less. You may want to look into peer-to-peer lending as well when investing for the intermediate term.
- For short term savings, you are looking at high yield savings accounts, bank CD’s and short term bonds. You would want to avoid stocks in this situation as the risk of losing your money is too great.
Always keep returns in perspective and focus more on achieving your goals. This way you will increase your probability of attaining them, whereas if you get caught up in returns, you may never realize your goals.