Correctly assess the risk of a short investment period (< 10 years)
You are thinking about a major purchase in < 10 years, but you don't know yet if it will actually happen and if so, when exactly you will make it (new car, buying a property, lover + divorce, ...)? Your heart is bleeding because your money is rotting in the call money account? But can not do otherwise, because any investment in ETF < 10 years is an incalculable risk? Then you should read this article!
Our world is not black or white. There are gradations, transitions are fluid. The reasons to invest (or not to invest) are different and individual. To be able to assess the risk and the opportunity, more detailed information is important. Only then can we make rational decisions depending on our individual risk profile. Based on the historical performance of the S&P 500, in this post we take a look at whether you are actually entering the front yard of hell if you only save an ETF for 1, 2, 5 or 9 years. And if not, how much higher is the risk compared to holding for 10, 15 or 20 years?
Important: This post deals exclusively with the risk you take with a short investment duration in a diversified portfolio. It does not consider the opportunities that such an investment duration offers. Neither does it consider strategies that involve buying & selling stocks early / often. The aim is therefore to be able to better assess the risk taken when the money invested for the long term may have to be paid out after less than 10 years.
Conclusion & tl;dr
If history repeats itself, an ETF on the S&P 500 can be invested for only 9 or possibly even 8 years instead of the often recommended 10 years - with a relatively low risk premium. In the case of a one-time investment, even an investment horizon of just 7 years would be completely unproblematic. Nevertheless, the past has shown that even with an investment period of 10 years, in the worst case a loss of up to 50% is possible with a one-time investment or 40% with a savings plan.
For the less risk-averse female investors among us, however, there is also good news: In the last 95 years, there has never been a time for a one-time investment / the start of a savings plan in / on the S&P 500 with which one was still in negative territory after 19 and 17 years, respectively.
Data basis and procedure
The analysis in this article is based on the performance of the S&P 500 index from December 1927 to June 2022 [1]. I would have liked to use a world index as a basis, but unfortunately I do not have sufficiently detailed data going back long enough. If you have some, please let me know. It should be noted that the performance of a specific ETF can of course differ from the index - e.g. due to annual costs, costs for the savings plan execution, the structure of the ETF and tax aspects.
Since the companies in the S&P 500 not only grow but also pay dividends, this was also taken into account [2]. For simplicity, I ignored the ex-dividend date and assumed a flat 27% tax on the dividend. Furthermore, I assumed a direct reinvestment of the dividend.
The procedure itself is relatively simple. Over different periods of time, the same amount is invested every month (for one-time investments accordingly only one month) and offset against the monthly appreciation (or loss) according to the index. After the savings phase, the invested amount is left for a certain period of time, if necessary, i.e. no further savings are made, before the money is then paid out. Dividends paid are taken into account over the complete period. The central question is: In how many cases do I leave the business with a loss, how high is this loss and how much do these figures change with falling / rising investment duration?
Assessing the risk correctly
We look at the absolute risk of loss: In how many cases (in percentage terms) was there a loss / profit for an investment period of X years? If 100 cases are considered, of which 98 cases end with a profit, the absolute risk of loss is 2%. However, if a profit is achieved in only 97 of the 100 cases, the absolute risk of loss is 3%.
The relative risk of loss is also an important indicator. It indicates by how many percent the risk of loss increases / decreases compared to a reference value. In the two examples from the last paragraph, the increased risk of loss in the second scenario appears so small at first glance that it can be ignored as an investor. What is 1% more risk or 3% total risk? Considerably more than you might think. Relatively speaking, the risk of loss actually increases by a whopping 50% (2% * 1.5 = 3%)! So the probability of making a loss in the second scenario is 1.5 times as high as in the first scenario.
In addition, it is necessary to consider how high possible losses are. Maybe as an investor I accept a 20% probability of having to sell my investment at a loss, as long as the amount of the loss is not more than 10%. On the other hand, a risk of loss of only 5% may be too much when the amount of loss could be as high as 90%.
Accordingly, all three ratios must be considered for a rational decision. What is the absolute risk of loss? By what percentage do I increase my risk of loss compared to the reference value if I exit earlier? And what level of loss should I expect?
The risk acceptance is very different from investor to investor, which is why everyone should ask themselves how much risk can be taken and at what point the risk is too great. Accordingly, you will be presented with the following key figures in order to be able to make an individual decision.
The reference (hold for 10 years)
Let's first take a look at our reference value: We invest once and hold for 10 years. In total, from 01.12.1927 every month until 01.05.2012, there are 1,014 possible investment dates. After 10 years, we are left with a negative result in 120 (without dividends) and 66 (with dividends) of the cases. This corresponds to a risk of loss of 11.8% and 6.5% respectively.
How often do losses occur and in what amount (incl. dividend)?
- 3x between 50% and 40%
- 8x between 40% and 30%
- 17x between 30% and 20%
- 23x between 20% and 10%
- 15x less than 10%
Unsurprisingly, the years / months around 1929 and 2000 were particularly prone to losses.
If, on the other hand, the S&P 500 is saved with a constant amount every month for 10 years, the risk can be reduced somewhat. In 94 (without dividend) or 29 (with dividend) of the 1,014 cases, a negative result was achieved. This corresponds to a risk of 9.3% and 2.9% respectively.
The losses break down as follows in this scenario (incl. dividend):
- 1x between 40% and 30%
- 5x between 30% and 20%
- 9x between 20% and 10%
- 14x less than 10%
Here the losses were taken at the start of the savings plan around the years 2000, 1930 and 1964.
So for risk reduction over a 10-year investment period, a savings plan on the S&P 500 made more sense in the past than a one-time investment.
Holding period < 10 years - data
How do the numbers change for a one-time investment and a 1-9 year holding period? @Kundenservice I would like to have the ability to format data as a table.
9 years:
- 1,026 possible investment dates
- 113 (without) / 48 (with dividend) negative results
- 11% / 4.7% risk of loss
- Reduction of the risk of loss by approx. 28%.
Losses (incl. dividend):
- 1x between 60% and 50%
- 6x between 50% and 40%
- 12x between 40% and 30%
- 11x between 30% and 20%
- 8x between 20% and 10%
- 10x less than 10%
8 years:
- 1,038 possible investment dates
- 140 (without) / 42 (with dividend) negative results
- 13.5% / 4% risk of loss
- Reduction of the risk of loss by approx. 38%.
Losses (incl. dividend):
- 1x between 60% and 50%
- 2x between 50% and 40%
- 7x between 40% and 30%
- 10x between 30% and 20%
- 7x between 20% and 10%
- 15x less than 10%
7 years:
- 1,050 possible investment dates
- 152 (without) / 62 (with dividend) negative results
- 14.5% / 5.9% risk of loss
- Reduction of the risk of loss by approx. 9%.
Losses (incl. dividend):
- 1x between 50% and 40%
- 6x between 40% and 30%
- 19x between 30% and 20%
- 14x between 20% and 10%
- 22x less than 10%
6 years:
- 1,062 possible investment dates
- 164 (without) / 91 (with dividend) negative results
- 15.4% / 8.6% risk of loss
- Increase of the risk of loss by approx. 32%.
Losses (incl. dividend):
- 7x between 60% and 50%
- 8x between 50% and 40%
- 7x between 40% and 30%
- 18x between 30% and 20%
- 13x between 20% and 10%
- 38x less than 10%
5 years:
- 1,074 possible investment dates
- 223 (without) / 139 (with dividend) negative results
- 20.8% / 12.9% risk of loss
- Increase of the risk of loss by approx. 98
Losses (incl. dividend):
- 4x between 70% and 60%
- 10x between 60% and 50%
- 15x between 50% and 40%
- 15x between 40% and 30%
- 8x between 30% and 20%
- 33x between 20% and 10%
- 54x less than 10%
4 years:
- 1,086 possible investment dates
- 246 (without) / 171 (with dividend) negative results
- 22.7% / 15.7% risk of loss
- Increase in risk of loss by approx. 242%.
Losses (incl. dividend):
- 4x between 80% and 70%
- 8x between 70% and 60%
- 10x between 60% and 50%
- 13x between 50% and 40%
- 11x between 40% and 30%
- 30x between 30% and 20%
- 40x between 20% and 10%
- 55x less than 10%
3 years:
- 1,098 possible investment dates
- 242 (without) / 189 (with dividend) negative results
- 22% / 17.2% risk of loss
- Increase of the risk of loss by approx. 265%.
Losses (incl. dividend):
- 1x between 90% and 80%
- 5x between 80% and 70%
- 11x between 70% and 60%
- 2x between 60% and 50%
- 4x between 50% and 40%
- 20x between 40% and 30%
- 41x between 30% and 20%
- 57x between 20% and 10%
- 48x less than 10%
2 years:
- 1,110 possible investment dates
- 266 (without) / 210 (with dividend) negative results
- 24% / 18.9% risk of loss
- Increase of the risk of loss by approx. 291%.
Losses (incl. dividend):
- 3x between 80% and 70%
- 7x between 70% and 60%
- 9x between 60% and 50%
- 8x between 50% and 40%
- 27x between 40% and 30%
- 34x between 30% and 20%
- 56x between 20% and 10%
- 66x less than 10%
1 year:
- 1,122 possible investment dates
- 348 (without) / 303 (with dividend) negative results
- 31% / 27% risk of loss
- Increase of the risk of loss by approx. 415%.
Losses (incl. dividend):
- 2x between 70% and 60%
- 5x between 60% and 50%
- 6x between 50% and 40%
- 21x between 40% and 30%
- 36x between 30% and 20%
- 85x between 20% and 10%
- 148x less than 10%
Holding period < 10 years - Conclusion
In the past, if an amount was invested once, it did not make much difference in terms of risk of loss whether it was invested for 7, 8, 9 or 10 years. Strictly speaking, an investment period of 7-9 years even had a lower risk of loss, provided that the dividend was reinvested. With an investment period of only 6 years, the risk of a loss remained in principle at a low level, but the risk of a high loss increased noticeably.
An investment period of 2-5 years already entails a significantly higher risk of loss. The amount of a possible loss also increased noticeably.
Although the maximum amount of a loss fell again somewhat with an investment horizon of only 1 year, at over 25% there was the highest probability of a total loss.
If the story of the S&P 500 repeats itself, the minimum investment period can be reduced to up to 7 years for one-time investments. Those who can live with the increased risk can also venture to 6 years. A holding period of 5 years or less is not recommended or only with a corresponding risk profile.
Savings plan < 10 years - data
9 years:
- 1,026 possible start dates
- 90 (without) / 34 (with dividend) negative results
- 8.8% / 3.3% risk of loss
- Increase of the risk of loss by approx. 14%.
Losses (incl. dividend):
- 1x between 40% and 30%
- 4x between 30% and 20%
- 13x between 20% and 10%
- 16x less than 10%
8 years:
- 1,038 possible start dates
- 103 (without) / 46 (with dividend) negative results
- 9.9% / 4.4% risk of loss
- Increase of the risk of loss by approx. 52%.
Losses (incl. dividend):
- 1x between 40% and 30%
- 3x between 30% and 20%
- 16x between 20% and 10%
- 26x less than 10%
7 years:
- 1,050 possible starting points
- 131 (without) / 78 (with dividend) negative results
- 12.5% / 7.4% risk of loss
- Increase of the risk of loss by approx. 255%.
Losses (incl. dividend):
- 1x between 40% and 30%
- 7x between 30% and 20%
- 26x between 20% and 10%
- 44x less than 10%
6 years:
- 1,062 possible start dates
- 159 (without) / 107 (with dividend) negative results
- 15% / 10.1% risk of loss
- Increase of the risk of loss by approx. 348%.
Losses (incl. dividend):
- 1x between 40% and 30%
- 15x between 30% and 20%
- 35x between 20% and 10%
- 56x less than 10%
5 years:
- 1,074 possible start dates
- 185 (without) / 123 (with dividend) negative results
- 17.2% / 11.5% risk of loss
- Increase of the risk of loss by approx. 397%.
Losses (incl. dividend):
- 1x between 60% and 50%
- 3x between 50% and 40%
- 3x between 40% and 30%
- 22x between 30% and 20%
- 36x between 20% and 10%
- 58x less than 10%
4 years:
- 1,086 possible start times
- 205 (without) / 140 (with dividend) negative results
- 18.9% / 12.9% risk of loss
- Increase of the risk of loss by approx. 445%.
Losses (incl. dividend):
- 1x between 80% and 70%
- 2x between 70% and 60%
- 5x between 60% and 50%
- 6x between 50% and 40%
- 7x between 40% and 30%
- 21x between 30% and 20%
- 32x between 20% and 10%
- 66x less than 10%
3 years:
- 1,098 possible start dates
- 242 (without) / 187 (with dividend) negative results
- 22% / 17% risk of loss
- Increase of the risk of loss by approx. 586%.
losses (incl. dividend):
- 3x between 70% and 60%
- 3x between 60% and 50%
- 7x between 50% and 40%
- 13x between 40% and 30%
- 30x between 30% and 20%
- 40x between 20% and 10%
- 91x less than 10%
2 years:
- 1,110 possible start dates
- 287 (without) / 231 (with dividend) negative results
- 25.9% / 20.8% risk of loss
- Increase in risk of loss by approx. 717%.
Losses (incl. dividend):
- 1x between 70% and 60%
- 2x between 60% and 50%
- 7x between 50% and 40%
- 11x between 40% and 30%
- 32x between 30% and 20%
- 48x between 20% and 10%
- 130x less than 10%
1 year:
- 1,122 possible starting points
- 342 (without) / 299 (with dividend) negative results
- 30.5% / 26.6% risk of loss
- Increase in risk of loss by approx. 917%.
Losses (incl. dividend):
- 1x between 60% and 50%
- 2x between 50% and 40%
- 9x between 40% and 30%
- 19x between 30% and 20%
- 60x between 20% and 10%
- 208x less than 10%
Savings plan < 10 years - Conclusion
If the savings plan ran for only 9 instead of 10 years before the payout, the risk of a loss increased only slightly. Even at 8 years, the risk of loss was - in my opinion - still within limits. With an investment horizon of 7, 6, 5 or 4 years, a significantly increased risk could already be observed. Moreover, after 5 years and below, the risk for a high loss increased significantly. With an investment period of 3 or 2 years or especially with 1 year, one already had to accept a high risk.
If one is to invest with a savings plan, it would probably be justifiable, according to the historical data, to reduce the investment horizon from 10 to 9 or possibly even 8 years. For even shorter periods, however, the risk increases sharply. Such a time horizon should only be chosen consciously and in consideration of the individual risk profile.
Leaving the money at the end of the savings plan
Did the risk change if the money was left for another year after the end of the savings plan before it was paid out? Since I don't want to torture you again with lists that go on forever, here's the short answer: If I pay into a savings plan for a year shorter and leave the money lying around for a year after the last installment in return, the risk increases minimally.
How much do I reduce the risk of loss if I hold my investments longer than 10 years / let the savings plan run longer?
As you might expect, each additional year of holding time provides a bit less risk. For a one-time investment, the probability of having to sell at a loss was only 1.7% (including dividends) after 15 years, 0.2% after 16 years, and 0% after 19 years. From an investment horizon of 12 years, the point in time of each loss-making one-off investment was before 1931. Thus, if we consider only the periods from 1931 onwards, the risk of loss was 0% for one-off investments from an investment period of 12 years.
The picture is similar for savings plans. Here, the probability of having to exit at a loss after 14 years was 1.9% (including dividends). After 15 years, the probability was only 0.4%. Somewhat surprisingly, the affected months in which the loss-making savings plans were launched were in 1959 and 1994. When a savings plan was executed, the probability of a loss was already 0% after 17 years.
But the S&P 500 is not the MSCI World!
Correct. As written, I do not have enough historical data for the MSCI World. But at least [3] provides a look back to December 1978. Comparing the risk of the MSCI World with the S&P 500 for the years 1979 to 2022, one sees a similar risk development - both for one-time investments and for savings plans. Even though overall the risk of the S&P 500 was slightly lower than that of the MSCI World in most of the periods considered.
Final thoughts
