The Third Pig

What To Do With Your 5 Year Money

Posted by Ben Taylor on October 7, 2008 04:13 PM

Jim Cramer, the self described innate optimist, has found himself the target of some scathing criticism today for giving a grim picture for the near future for returns in stock market. On Monday, on NBC’s Today Show, he advised viewers to pull their “5-Year-Money” out of the stock market and place it in cash. Almost instantaneously, and I might say coincidentally, the market dropped significantly. [Click chart for larger image.]

Source: Bespoke Investment Group

Although this makes for good television fodder, the criticism of Cramer in this instance is overblown. Cramer is exceedingly popular. His books are bestsellers. His show is one of the highest rated on cable television. But I doubt Cramer’s comments can move markets. Small, individual stocks, maybe. But not markets.

Despite the criticisms, Cramer’s advice is not only timely, it’s timeless. Your 5-Year-Money should always be in safe (low volatility) investments, even in the best of times. And I don’t say this because Cramer’s advice is identical to the advice I gave just a few days ago. I say it because it is simply sound asset allocation.

Stocks are great investments, but they are also the most volatile of investments. Thus if an investor’s time horizon is less than five years, and he needs to pay for his kid’s college tuition or put his mother in a retirement villa or finally replace his old jalopy to get to work, in that time frame, it doesn’t make sense to take the risk. Although stocks rise most of the time, they don’t all the time. In some situations, cash makes more sense.

In periods of 10 or more years, stocks beat cash 85% of the time. But in periods of 1 year or less, stocks only outperform 65% of the time. Although we just gave this advice, it’s well worth repeating:

  • For money you need within 5 years – “5-Year-Money”: Keep those funds in an interest bearing account at your bank of choice. Congress has approved and the President has signed into law that the FDIC will now insure up to $250,000 in deposits at banking institutions.

  • For money you need beyond 5 years: Invest or keep your money in a diversified (at least 20, no more than 30) portfolio of stocks of low leverage (companies that don’t make use of debt), high return on capital companies. If you have cash available, and it’s not paying for Johnny’s second semester at State U., you would be wise to add to your portfolio.
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