investment plan for 25K

I need some guidance from the group. I am 30 yr and am looking for advice to invest about 25K cash.

Situation: I have 401K savings totaling 45K. I max my 401k currently and plan to continue that in near future. I have no major CC/debt and have emergency fund of 8K. I prefer at this stage moderate risk.

This 25K money I was saving for the mortgage downpayment; Due to current personal situation, I will not be buying a home in the next 5-6 yrs. I may be looking to use this money over span of next 4-5 years on either education (MBA) OR mortgage downpayment when that happens.

any suggestions welcome!!

I am ok in terms of investing in oversears MFs, index based funds or bonds. I think I would not be comfortable say in REITs or individual stocks. Please suggest which markets/style/percentage allocation I should consider.

Thanks in advance. Samsai

Reply to
samsai
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The timeframe is the issue here. Under 5 years, you really need to be in a fixed investment. Over 5 years, you really want to be in the market. You are sitting on the fence between these two timeframes. The option is to redo your plan and really nail down your future timing, or error on the side of safety.

-john-

Reply to
John A. Weeks III

Since I am ready for moderate risk, I was thinking about 5% return on fixed investment will be low for my risk appetite. Though I dont want to loose it all (no one wants that), I was looking for some advice in MFs investment... Should I look into index based funds and/or bonds?

Please suggest which markets/style/percentage allocation I should consider.

For ex. last year YTD returns > In article ,

timeframe is the issue here. Under 5 years, you really

Reply to
samsai

Nothing is certain in life.

  1. don't forget the impact of taxes

  1. If you look at investing money in 1999, and taking it out in March

2003, that gives you an idea of the scope of how much you can lose. About 50% I believe. Obviously in the case of the NASDAQ, you could have lost over 80%.

Risk and return are correlated.

An US total market or large cap index fund *should* produce returns of around 8% pa over the long haul (historically the returns were much higher, but I think they will be lower in the future, I am assuming inflation of 2.5%). The only sure return (nearly sure) from that is the dividend yield though, typically about 2% pa.

By contrast, a 5 year US government bond pays about 4.5%.

Say, for sake of argument, that the risk return tradeoff looks like this:

return risk (% change in value of portfolio y-on- y) Bonds 4.5% 10% (1994 was about the worst year in recent history for bonds, bond indices dropped about 20%). If held to maturity, US treasury bonds have no risk (of losing the face value you invested- -inflation is another matter).

Equities 10% 20%

You can see then how you can construct a portfolio with a return of between 4.5 and 10%, and what risk you will be taking on.

I think what you need to do is assess your own comfort level with risk and return.

My own view is, as other posters write, no one should invest in equities with less than a 5 year view (ideally less than a 10 year view).

For that part of the money that you *need* to have in 5 years, you either invest it in multi year CDs, money market funds or government bonds.

The rest, you can *bet* on equities. In which case I preach diversification (eg the Vanguard Total Market index fund), low cost (ditto) and minimum capital gains distributions (again, passive management tends to minimise these relative to active management.).

You may wish to use different return numbers, especially for equities. My view is that in a world of 2.5% economic growth, and

2.5% inflation, profits of US companies are likely to grow at around 5.0%. Earnings per share might grow at around 6% (due to the effects of stock buybacks, take privates etc.). Add another 1% for exposure to fast growing emerging markets (but then do we deduct 1% for exposure to Europe and Japan, which are growing more slowly?), and you get to 8%. This is also the limit, long run, in growth of dividends (you can only grow dividends faster than earnings by eroding dividend cover).

(they have been growing faster than that of late due to recovery and because the share of profits in GDP has risen to all time postwar highs, or put it another way, wage earners have not been able to claw back the growth in corporate profits in wages and salaries. I don't expect either factor to continue indefinitely).

Now the sources of return for equity investors are:

  1. profits growth (per share)
  2. price earnings ratio changes (multiple expansion)

The former we've said is 8% pa. The latter has been a huge factor in generating stock returns since 1979, but PE multiples have fallen since 2000.

My own view is they cannot expand by much more *unless* inflation and hence interest rates is lower in the future than they are now. Because fundamentally there is a tradeoff between owning bonds and owning stocks, and that is the interest cost of money*.

So my (guess) is 8% is a reasonable long run return to expect from US stocks *unless* you think either economic growth or inflation is going to be higher than I am forecasting (2.5% pa).

If you do, then bonds are probably very overvalued. Bond yields should be 5 or 6%, not 4.5%.

My other view is that most US housing markets are still headed for a smash. So having cash to buy a house in 2-3 years, when the market finally bottoms, could be a very good thing. See the various housing bubble blogs for more discussion and analysis.

  • someone well read will note that this is called 'the Fed Model' and it doesn't stack up. The Fed uses it to predict the stock market, but theoretically comparing a nominal bond yield to a real return from stocks is incorrect. All I can say is that in the long run, I have observed if inflation rates fall, then stock market PEs tend to rise.
Reply to
darkness39

Darkness I always enjoy your comments. Three questions:

  1. In looking for an 8% long haul return, what time frame do you use with the term "long haul" (10 years, 25 years, etc.)?
  2. Is your 8% the total return with dividends reinvested - not just a price-only index?
  3. Lastly, is the 8% after or before the expected 2.5% inflation?

-HW "Skip" Weldon Columbia, SC

Reply to
HW "Skip" Weldon

comments. Three questions:

30 years is a sensible period of time.

There was a mistake in what I wrote above.

Your third source of return is your dividend income.

So we have

- increase in price which comes from increase in earnings (1) and increase in multiple (2) (via the mechanism of the PE ratio)

- your dividends

Now the increase in dividends *from now* should be covered by the increase in profits (either the higher profits are paid out to investors as dividends or reinvested by the firm, either way the investor gets the benefit).

But your initial yield is 2.0% say, on the SP500 now.

So the return would be:

2.5% inflation + 2.5% economic growth + 1% for various improvements in corporate earnings profiles (eg buying back shares) + 2% initial dividend yield = 8%

(note I'm being conservative, US economic growth has historically been closer to 3% than 2.5%)

There are complications:

- quoted US companies grow profits by about 1% less pa than US companies as a whole (why is an interesting question)

- my calculation re the impact of foreign economies is somewhat specious, in the sense that economic performance of foreign economies feeds back to the US economy (so there is double counting there).

After. So historically we have done much, much better than that.

Which is one of the reasons why I think it will be hard, long term, to return more than that.

Reply to
darkness39

I agree with other posters that investing in fixed income for a 5-6 year time horizon. If you would be comfortable with risk of principal, a mix of around 50% equities and 50% bonds/ fixed income would be the maximum I would sugest. If you did this, once you knew when you needed the money, I would move 100% to bonds.

If you are confident in a 6-7 year time horizon (for whatever you needed money for), consider a 50-50 mix in year 1, Each year sell 10% of the equities (and convert to fixed income). This could boost returns "some" over the 4.5% I would expect from bonds. The major issue in this situation is a down year early would significantly reduce returns.

Reply to
jIM

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