Respecting Time Horizons

You can’t learn all there is to know about financial planning from a textbook.

To excel in the craft of financial advice, one needs time in chair; a collection of diverse experiences and unique situations that fine-tune their skills.

Looking back at my own career, I’m somewhat shocked that years ago, a household name investment firm was willing to put me in front of clients after passing a few fairly simple license exams.

Was I ready and equipped to give advice on day one? I’m sure I was not, but pursuing this career was a dream, so I was determined to figure it all out. An insatiable curiosity led to lots of web browsing, plowing through a wide range of finance books, and many hours spent listening to podcasts. All of this preparation and study really helped to accelerate the development of my own competency.

When you are new, you typically try to keep things simple. You follow the playbook and try to stay in your lane. I did just that – I met clients, provided the company risk survey for them to complete, then matched their results to one of the company-managed model portfolios. Nowadays, I absolutely reject this approach and criticize this common practice, but this was the original approach to advice/planning that I was taught.

As I matured in my craft, I began to give much more attention to time horizons as opposed to risk tolerances.  Both are important, but the weighting of importance is very different from my perspective.  I became much more determined to find out how long someone planned to stay invested and when certain monies were being earmarked to be spent. I figured that it was my job as an advisor to design the most suitable portfolio based on my client’s goals, and it was my job – through education and constant dialogue/support – to help my client tolerate the portfolio that best fit their goals.

Think about it this way, let’s say an investor had a goal to retire in 30 years and let’s assume they weren’t very well versed in markets.  Then they completed one of those risk surveys and self-identified as a “conservative” low-risk investor. Their specific goals (e.g., how much they’d like to spend in retirement) would define what sort of returns are needed, and their time horizon may justify owning investments that are more volatile in the short run, but ultimately their self-defined tolerance would limit the type of investments they could own.  This is a problem.

I’d argue that one can’t create more time – your time horizon is what it is. Yet one can become more tolerant if (1) they are shown the clear benefit associated with doing so and (2) they have an advisor to help provide the needed support to endure through difficult markets.

Now, here’s why I’m writing on this topic today. I’ve had four different friends ask me for investment advice in these last two weeks. Each said that they had a bit of extra money and wanted to know where to allocate it. The first question I asked each of them was when they planned to spend this extra money. The common answer was that they weren’t exactly sure, but most likely in the next year or two. This made my response easy, I guided them toward either buying a one-year treasury that would yield roughly 4.5% or resourcing a liquid money market fund that would yield somewhere around 4%.

Is this advice exciting? No. So, what was the common reaction to my advice? They wanted to know about the stock market and if I had any ideas for generating double-digit returns. My response was the same as it always is – you have to respect time horizons.

If you look at the stock market over the last 52 rolling five-year periods, you would find a few interesting tidbits. You’d find that the median return over those time periods is 13.96%. In 7 out of the 52 five-year periods, returns were negative. In 12 out of the 52 five-year periods, returns were less than the current fixed rate on the five-year treasury. At first glance, one might think that the average (median) return looks attractive, but as an advisor, I’m going to encourage you to study the probabilities rather than the averages. If history is our guide, we’d expect 13% of the time returns to be negative and 23% of the time returns to be less than the current treasury rates for that five-year time horizon.

So, if you’ve earmarked some money for a new home purchase or a home improvement or a vacation or tuition, or whatever you’re saving for, it would be unfortunate to have your savings worth less when you are ready to spend it.  If I told you there was a 13% chance that your upcoming flight was going to crash, you wouldn’t board that plane.  If I told you that your next dining experience would have a 23% chance of getting food poisoning, you would skip that meal.  So, why would you put your savings at risk of not being able to cover the expense it’s been designated for?

It is true that you can’t precisely predict returns when it comes to investing, but you can study market history and position yourself where the probabilities are in your favor.  You must respect time horizons.

Keep it simple, if your time horizon is short, use an investment that provides a defined return for your desired term.  If your time horizon is longer, work with your advisor to design a portfolio that helps to maximize outcomes and put the odds in your favor.

I’ll conclude our discussion today with a quote from David Bahnsen’s 2023 White Paper:

“The drawdown in the Nasdaq of -35.1% from its November 2021 high now leaves the Nasdaq with a compounded annual return of just 3% per year for the last 23 years, the golden era of technology. Booms and busts do nasty things!”

What a great reminder of what risk is and how severe drawdowns can put a major damper on long-term returns.  Think about the technological advances over those last two decades, which leads one to assume that technology investments would have delivered abundant results.  This a good reminder that both valuations and time horizons need to be respected and heeded.

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About the Author

Trevor Cummings

Private Wealth Advisor, Partner

Trevor is a Partner and Director of our Private Wealth Advisor Group.

As the author of TOM [Thoughts On Money], Trevor endeavors to write and speak about financial concepts and principles in a kind of “straight” talk demeanor and posture.

He received his Bachelor’s degree in Organizational Leadership from Biola University and his MBA from California State University, Fullerton.