Stocks are no place for your spending money

Imagine you’re planning a major expenditure twelve months from now. The down-payment on a vacation home in Florida. An around-the-world cruise aboard the Queen Mary 2. Freshman-year tuition at Washington University for your granddaughter.

You’ve got all the money put away, invested in an S&P 500 index fund and you’re just waiting for the big day a year from now. And when that happy day arrives, you discover to your horror that the money you saved for your dream home/vacation/gift-of-a-lifetime has lost more than a third of its value.

That’s not hypothetical, by the way. It’s actually happened in three calendar years since 1928: -43% in 1931, -35% in 1937, and -37% in 2008. In fact, the S&P 500 has lost money in 25 of the past 95 calendar years, more than one year out of four on average.

What’s the lesson here? That despite historical returns that are much higher than bonds or cash equivalents, stocks are simply no place to keep your spending money.

In fact, I generally don’t recommend stocks for any money you plan to spend over the next five years, at a minimum. Stocks had negative returns in 12 of the 90 overlapping five-year periods from 1926 through 2019.¹ That’s about 13% of the time.

While equities have historically outperformed bonds and cash over long time periods, their short-term returns are unpredictable and some would even say random. Funding your short-term goals with a long-term investment vehicle, therefore, is a recipe for costly disappointment. One of the biggest risks of owning stocks is being forced to sell them when you don’t want to.

When Wash U sends the bill for your granddaughter’s fall tuition, they won’t delay the start of classes while you wait for your stocks to go back up. Better to have those funds parked in short-term savings vehicles, such as bank accounts, short-term CDs, or money market funds, where you know you will have access to the money when you need it, even if it earns very little while it sits there. Remember, when it comes to your near-term spending goals, safety and liquidity are far more important than returns.

Turn on CNBC today and you’re likely to hear an hourly debate on what investments will earn the highest returns over the coming year: Will stocks keep outperforming? Will rising interest rates mean negative returns for bonds? Or is sitting in cash the best play for the time being?

I think those are the wrong questions for people like you and me. We’ve got real-world goals and plans, things we want to spend money on this year and next year and 10 years from now. We don’t need to be predicting the future; we should be planning for it.

My general advice is simply to invest your money based on when you plan to spend it. Anything you plan to withdraw from your portfolio in the next 12 months should probably be held in cash equivalents. For whatever you plan to withdraw over the following five to 10 years, consider a well-diversified assortment of fixed-income securities. And for your long-term needs, equities might be appropriate. As you withdraw cash over the year ahead, replenish it with the income your other investments produce.

It’s a simple approach to building a portfolio, but it sure beats watching CNBC all day.

¹ Ibbotson Large Company Stock Index, reported by Morningstar (2020)

This information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Opinions expressed in the attached article are those of the author and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice.