To accommodate the different investors’ levels of risk tolerance, we use four basic risk models: Conservative, Moderate, Growth, and Aggressive. Each refers to the time horizon of the investment.
Conservative Portfolio: 1-3 Year Time Horizon
With a time horizon of one–three years, it is typically advisable to put up to 25% of your money into stocks. The market may drop within a single year, but it is most likely that the investment will hold its value after two or three years. The remaining 75% of your funds should go into a mix of cash equivalents and short-term bonds.
Moderate Portfolio: 3-5 Year Time Horizon
If you plan to buy a house in four years, you can probably tolerate the risk, and reap some reward, from putting up to half of your investment into stocks and the remainder into bonds. This mix is intended to grow and preserve your money at a faster rate than short-term investments would. The additional time makes the risk easier to bear. Since bonds often move contrary to stocks, this arrangement helps control volatility within your portfolio. Adding more stocks also helps offset inflation risk.
Growth Portfolio: 6-9 Year Time Horizon
Six–nine years is a comfortable investment period. Looking back at history, the stock market typically recovers from slumps within this
time frame. For example, as the chart above illustrates, the S&P 500 recovered from the 2008-2009 “financial meltdown” in five-and-a-half years. Even with the Great Depression, the stock market plummeted, but eventually rose again. Plus, the divergent returns of stocks vs. bonds help control your portfolio’s volatility.
Aggressive Portfolio: 10 or More Year Time Horizon
Young investors have long time horizons, and as such should have aggressive portfolios. This portfolio is 100% stock-focused; that is, it is totally focused on growth. That may sound very risky, but it is a good hedge against inflation. (A 100%-stock portfolio can still be well diversified by varying the asset classes of the stocks.) In addition to minimizing inflation risk, the aggressive portfolio gives you the best chance of higher returns in exchange for higher market risk and volatility.
A 100%-stock portfolio should have a time horizon of at least 10 years to weather downturns in the market. In the worst case scenario, $100,000 invested in stocks would still be worth at least $100,000 ten years later. You would not be pleased with this outcome, nor would I, and while it is possible, it is probably the worst case scenario even though it’s the riskiest form of allocation. Remember the Investor’s Dilemma? In these circumstances, the key is to continue to hold.