Match investments to when you need the money. A home-purchase example explains risk capacity, short-term goals and the trade-offs of changing allocation.
February 26, 2024 · Financial Forte Staff
Historical article: prepared retrospectively using information available as of February 26, 2024.
The investment account may still have the mix you chose years ago, even though the money now has a different job. A balance once intended entirely for retirement might also need to fund a home purchase next year. Or retirement may be approaching while part of the portfolio still needs to support spending many years from now.
Your time horizon is the period before money is needed, not simply your age or retirement date. Matching investments to that timing can help you avoid asking a long-term investment to solve a short-term cash problem. It also helps prevent a near-term need from making the entire portfolio unnecessarily cautious.
Identify when each part of the money will be used
Write down the larger withdrawals you expect and their approximate dates. Separate an essential payment with a fixed deadline from an optional expense you could postpone. Both are goals, but they may have different capacities to absorb a market decline.
The SEC's investor education materials connect asset allocation with time horizon and tolerance for risk. Asset allocation means dividing investments among categories such as stocks, bonds and cash. The appropriate combination depends on what you need the money to accomplish and the risks you can accept.[1]
Retirement rarely creates one deadline for an entire account. You may need some money soon and some over many later years. Treating every dollar as though it will be spent on the retirement date can overlook that longer need. Treating every dollar as distant can leave upcoming withdrawals exposed to more fluctuation than you intended.
The account's label doesn't solve the question. An IRA, brokerage account or workplace plan can hold different investments. Review what is inside it and which expenses you expect it to support.
Test a near-term goal against an unfavorable result
Consider a hypothetical investor, Renee, who expects to use $50,000 from a $400,000 portfolio for a home purchase in eighteen months. The rest is intended for retirement and later spending. She currently views the full account as long-term money.
To test that assumption, suppose the investments assigned to the purchase declined by 20 percent before she needed them. The $50,000 would become $40,000, leaving a $10,000 shortfall. This is a hypothetical stress test, not a forecast or an estimate of the probability of a loss. If Renee cannot replace that $10,000 or postpone the purchase, the current risk assigned to the purchase fund deserves immediate review.
Renee can now evaluate the consequence. Could she postpone the purchase, buy a less expensive property or fund the difference from another source? If none of those options is acceptable, the money's eighteen-month job deserves a more stable and accessible arrangement than she might choose for a goal decades away.
That does not dictate the allocation of the other $350,000. Those dollars have different expected uses. Separating the decisions helps her evaluate the short-term need without abandoning the longer-term plan. The remaining retirement money may itself have several spending dates, so it does not automatically belong in one uniform allocation.
The same reasoning applies to an expense that is smaller than a house purchase. A known tuition payment or necessary repair can create a firm deadline even for someone who otherwise has a long investment horizon.
Distinguish comfort with risk from capacity for loss
You may feel comfortable watching investments fluctuate, yet lack a practical way to replace money lost before an essential payment. Conversely, you may have substantial flexibility but feel uncomfortable with market changes. Both the financial capacity and the emotional response belong in the discussion.
A useful question is what you would actually do after an unfavorable outcome. If the answer is “sell immediately because the bill is due,” that money has less flexibility than a statement about being a long-term investor suggests.
For longer-term money, the opposite concern also matters. Keeping everything in cash may reduce some short-term fluctuations while exposing purchasing power to inflation. The decision involves competing risks rather than a choice between risk and no risk.[2] A reserve for an eighteen-month purchase and an investment allocation for spending twenty years from now can sensibly look different within the same household.
You don't need a prediction of next month's market to identify those trade-offs. You need realistic spending dates and a clear picture of what could change.
Review the transition before making trades
Once you identify a mismatch, consider how to address it. New savings or cash already available may help fund the near-term goal. Selling investments can also be appropriate, but transaction costs, taxes and the effect on the remaining portfolio need attention.
An investment described as conservative may still lose value. Bonds can fluctuate, and different cash or cash-like arrangements have different access terms and protections. Confirm what you own rather than treating a category name as a guarantee.
If you shift money for the home purchase, review the allocation of what remains. Removing only the portfolio's most stable holdings could unintentionally leave the retirement portion with more risk than intended.
Set a regular review and identify events that would justify an earlier one: a new purchase, an earlier retirement date, a change in income or a significant shift in family needs. Those developments can change the job of the money even when the account balance looks familiar.
Start with the next three larger withdrawals you can reasonably identify. Assign each a date and note whether it can move. Your portfolio can then be evaluated against the life it is meant to support, instead of an allocation chosen for circumstances that no longer exist.
Related reading
- Risk Tolerance and Risk Capacity Are Different Questions
- Rebalancing Without Reacting to Every Headline
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Educational information, not personalized investment, tax, legal or benefits advice. Examples use hypothetical assumptions. Verify current rules and your circumstances before acting.
