Wednesday, January 21, 2009

Should I Invest? #1: Timeframe

This is the first of a 3-part article. With the economy in what I've heard called 'the Sandpaper stage' (back and forth, rubbing out your savings), I've talked to a lot of people about when to get in the market, or whether to get out completely and take the loss.

To me, this begs a bigger question: Should you be in 'the market' at all? To which I have three questions. The first is: What is your timeframe?

It has been said the market is long-term a weighing machine, and short-term a popularity contest. This means that a good company, over time, will show it's fundamentals and be valued for being a good company. Unfortunately, it also means that it could take a long time to show that value, and be all over the place in the meantime. This is why most stock charts look so jagged, up and down. It's also why Blue Chips look smoother - their value has been established, so there isn't so much debate on price. See an excerpt of Warren Buffet's view on this here.

In our current economy, I would say that, to be safe, you need a time horizon of at least five years to be reasonably confident that you'll get to the 'weighing machine' part. If you will need your money in less than five years, you might not want to count on fundamentals alone to choose your investments.

Some History
Look at a graph of the S&P 500 over the since the beginning of 2000: it was at 1527 on March 20, 2000; then dropped and climbed back to 1561 on Oct 8, 2007; then fell again since then, and is now at 827. Which means if you bought an S&P 500 index fund in early 2000, you would have spent 7 1/2 years getting back to your starting point, not even a profit. Who knows how long until this latest drop comes back? Forget five years - from 2000, you're looking at ten years at the least!

Question #1
So the first question to ask yourself is, "What is my timeframe?" Think about it seriously and write down when you'll be needing that money back. Only once you know that can you think about the next step, your belief about the future.

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