A reader named Greg recently sent in the following question:
"I recently sold my house and netted $50,000. I have about a year and half before I purchase another home. I'm thinking about investing this money in stocks. My goal is to make upwards of $20,000 in that time frame. Is this attainable? What would you suggest to do with it?"
It looks like someone has been asleep for the last three years.
At the end of 1999, turning $50,000 into $70,000 in a year and a half looked positively easy. But with the market's collapse, most people have learned two things: It's hard to make a fat return in stocks over a short span of time and you can lose a lot trying.
When you're investing with a horizon of just a year or two, you either have to limit your risk and potential upside or prepare yourself for a major loss.
And here's how you can decide if you should gun for that big gain.
If you're going to throw your money into stocks for a little over a year, you should be prepared to lose some, if not most, of that cash -- roughly 30% to 80% of it.
Think of it this way: Any percentage gain that you're trying to make in a short period of time is the percentage that you should be prepared to lose.
The bigger the return you shoot for, the more risk you have to take to get it. And a 40% return in 18 months is a tall order. And you cannot possibly get there by owning a broad mix of stocks, bonds and cash. It's feasibly impossible. There's probably never been a single year in history when a truly diversified portfolio delivered that kind of return. The
Janus Balanced fund came close in the late '90s, but that performance sprang from the combination of extra risk and a lot of luck.
An all-stock portfolio is risky enough that you could lose half your money from peak to bottom. And that's a diversified index like the
. In riskier stocks, the potential losses are even greater.
shot up more than 100% in 1999. But it also fell 37% the following year.
Yes, stocks -- particularly tech stocks -- have come way down from their highs of the late '90s. But no rule exists that says stocks can't lose another 50%. Sure, the market has already collapsed and stocks do look cheaper. But you can still lose in stocks.
And unless you blatantly want to gamble, you shouldn't put money in the market that you know you'll need a year or two from now.
With so little time, most of that cash should be in, well, cash -- a money market fund. You should be taking very little risk with it. And even Treasury bonds can crater as rates rise. The
Vanguard Long-Term U.S. Treasury fund, as one example, lost almost 9% in 1999.
You have to decide how much money you can lose before you make any asset-allocation decisions. Here's a quick calculation: Take the percentage you're comfortable losing, double it and that's how much money you can have in stocks.
And if the market tanks, you should be prepared to buy a much smaller house, or even rent.