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The 5 Year Stock Market Rule
Posted By Jim On 01/23/2008 @ 9:27 am In Investing | 6 Comments
Don’t invest in the stock market unless you’re going in for 5 years. That’s the principle I operate under when it comes to investing in the stock market. Unless the funds I’m committing are free for the next five years, I’m not putting it into the stock market. It’s not a rule grounded in deep analysis or one created by an expert in the market (but experts have come up with similarly sounding rules with different time horizons), it’s simply one that I got in my head and one that has served me well thus far. The time isn’t the important part of the rule, the idea behind it is.
When it comes to the volatility of the stock market, it’s important that you think in the long term. In the short term, emotion often sways the performance of both the market and individual stocks. Apple has a bad quarter, everyone panics and sells the stock. The CEO of Under Armour announces he will be divesting some of his ownership shares, UA falls 50% in three months. Everyone thinks there is a recession, stock market is tanking, Fed steps in, and now it’s not nearly as bad as it used to be (as of this writing, international markets have begun rebounding incredibly off the Fed rate drop news). Either way, there are a lot of things that affect the stock market that have a lot to do with external factors (I don’t think the economy is an external factor, I was merely using it as an example of how emotion can play a large role). Those external factors are difficult to gauge and this they contribute to a volatility that is only bearable if you have time – hence the five year rule.
If you are limited by a concrete timeline, self-imposed or otherwise, that is less than five years, I recommend that you don’t put it into the stock market. A prime example for someone in my age group (I’m 27) is your house buying fund. If you intend to make a purchase in the next five years, I strongly urge you to leave those funds in something safe because the allure of historic 11% annual returns could pull you into a situation where you lose 11% in a month (such as the one we’re in right this very moment).
If this sounds eerily familiar to the advice you read for retirees, it’s because it’s exactly the same. If you are looking to retire on your investments, you should start divesting yourself of equities as you near retirement. You’ll want to keep some of it in stocks but given the immediate need of the funds, you’ll want to keep only that percentage you can live without for some period of time.
Do you use any sort of rule like this when you decide whether to commit funds to the stock market? It was a big jump for me to start investing non-retirement funds into the stock market and I started using this rule as a way of slowing down my eagerness and reducing my exposure to risk.
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