Investing 5 Year Time Horizon

It is good to know the performance over a 74 year period or 60 year period or a 10 year period. How do you invest if you have a 5 year time horizon? To answer the question, we will look at the minimum return, maximum return, and percentage of time for a positive return for a Small Cap Stock Index, Large Cap Stock Index, Long Term Bonds, and Short Term Bonds in the book Investments.

We will look at the time period from 1926 - 1999, to include the Great Depression and 1940-1999 to reflect a more normal period. It depends if you want a true worst case or a more normal environment.

Time Period 1926 - 1999

Investment/Min Return/Max Return/% Positive Return
Small Stocks/-17.94%/75.36%/90%
Large Stocks/-9.79%/28.71%/91%
Long Bonds/-2.34%/16.38%/97%
Short Bonds/-0.42%/11.31%/93%

Time Period 1940-1999

Investment/Min Return/Max Return/% Positive Return
Small Stocks/-14.31%/56.15%/95%
Large Stocks/-0.75%/28.71%/98%
Long Bonds/-2.34%/16.38%/96%
Short Bonds/0.12%/11.31%/100%

What conclusions can we draw from this data:

1. The data during 1926 - 1999 is starting to look a little wierd. The % positive return for short term bonds has dropped to a level below long term bonds which does not make sense except that a large negative value can have a lingering impact.
2. The minimum return data shows mixed results. Small stocks which gave the best long term performance had the worst numbers. An investor's view that the future environment might include a depression will guide investments toward bonds while a view of a more normal environment will guide investments toward large stocks.
3. The maximum return data shows that stocks outperform bonds. Small stocks that had the most negative minimum return value has the largest maximum value indicating the most volatility. Large cap stocks and long term bonds got closer together.
4. The percentage of time that a positive return had mixed results. Short term bonds had the highest value and got to 100% during the 1940-1999 period. Large stocks during the 1940-1999 period had a positive return 98% of the time. Long term bonds during the 1926-1999 period had a positive return 97% of the timer. Surprisingly, large cap stocks had a higher value than long term bonds during 1940-1999.
5. If you are concerned about losing money on your investment, a short term bond is the right answer, as it has the highest minimum return value and highest percent positive return. Depending upon your view of the future environment, large stocks came close at 98%.
6. If you are an aggressive investor that only has a focus on the maximum gain stocks outperformed bonds by a wide margin.
7. We see some unique situations develop between these 2 time periods so your view of the future starts to impact how to invest. If you believe that the future is more like the 1926-1999 time period then bonds are clear winners when looking at the minimum return data. If you believe that the future is more like the 1940-1999 time period then one would purchase large cap stocks instead of long term bonds because they have a better minimum return, large cap stocks have a higher maximim return and a higher % positive return.
8. Bottom Line: Your view of the future starts to come into play. Stocks had the greatest potential for growth and the greatest risk in the amount of loss. Large cap stocks look better than long term bonds in a normal investing environment.

If you have a child going to college in 5 years and your view is of a relatively normal investing environment in the future you should be looking at mutual funds that contain large cap stocks, mutual funds that contain long term bonds, and short term bonds or a money market account. If your view of the future is a worst case scenario, you need to be investing in mutual funds that contain long term bonds, and short term bonds or a money market account. Remember that the tuition payment is due when the tuition payment is due, regardless of what happens in the stock market.