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  • Writer's pictureNicholas Pihl

How to invest when you are less than 10 years from retirement

Updated: Feb 2, 2022

Over the long term, the S&P 500 has produced total returns of around 10% per year. At least when you measure results over a given 40 year period, which is a stretch of time that is just as long, if not longer than your entire working life.

And therein lies the rub. Over periods that aren't 40 years, say, only 2 or 3 years, stock returns are a lot less predictable. And they aren't always positive. That presents some challenges for planning. But first, here's some data to guide your expectations for investing in the stock market.

When held for just one year, the stock market has positive returns just 73% of the time. If held for three years, that average "likelihood of winning" goes up to 84%. Now, maybe you're saying, "I like those odds," and I agree. But my larger point is that over the short term stocks are anything but a sure thing. Don't invest for the short term with money you'll need. Shorter term holdings include things like cash, T-Bills, even investment grade bonds.

If you really want to get "aggressive" with this short term money, you can mix in small amounts of stocks with the safer investments. Maybe 10% stocks vs 90% safe money. In a really bad year, stocks might lose 50% or more, which is roughly 5% of your portfolio. Net of interest and gains on your safer investments, you might only be down 2-3% overall. If you can live with that and make up the difference from your other income sources, that might be something to consider.

I wouldn't recommend going heavily into stocks with cash you'll need soon. But as your holding period increases, the more sense it makes to own stocks.

For 7 year holding periods, your odds of making money in stocks rise to around 97%. But there's quite a bit of variability within that number. Some 7 year periods are very good. For instance, if at the end of 1955, you'd held stocks for the prior 7 years, your annual returns were around 24%. Per year.

On the other hand, holding for 7 years through the end of 2008 would have lost 1.54% per year (for an 11.29% total decline). Similar story up through 1974, when you'd have lost 1.46% a year (a 10.68% total decline). That sucks, but keep in mind, we're talking about a worst case scenario that happens rarely.

And of course, you have everything in between, from -1.54% a year to +24% a year, including many periods with low-single-digit returns, and many periods with high-teens returns.

When you have 7 years left to retirement (or your other goals), and still need more growth, what do you do?

There are two pieces to this. One, is keeping your expectations reasonable. Even if 10% returns are the 30 year average, there's no guarantee that you'll earn 10% over a 7 year period. So don't put yourself in a position where you're counting on that. That might mean saving more, or being willing to wait a little longer if you have to.

Secondly, you can narrow your range of outcomes by holding a mix of different assets, including bonds and real estate, not just stocks. A blended portfolio like this likely won't have anything like the 24% annualized growth rate like we saw through 1955. But it's less likely to have poor returns too. You're more likely to get that middle-of-the-road, 5-8% return.

But of course, this isn't advice for you specifically. This is just general information, food for thought. The right answer for you depends on your situation, both financially and personally. If you've got other sources of income, that matters. If you're the type to worry about your investments all day, that matters too. Even whether you're happy at your job, matters. Good, thoughtful financial planning takes this all into account, and sets you on the path that works best for you.

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