Investing with a 10 year horizon

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TheoLeo
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Investing with a 10 year horizon

Post by TheoLeo » Sun Apr 08, 2018 1:53 pm

New to this great forum and already have a question.

In the next ten years I will be able to earn and save the amount of money that I will then need to invest in my business (nothing exotic and low risk, really). If I lose some of this money along the way, I will have to take a loan.

My approach so far is to simply go 100% cash to make sure I will have what I need until then, so I won´t have to take a loan.
Since I live in germany the banks give about 0,5% interest on it if you lock it up for 10 years. German government bonds are not yielding much more. Euro bonds are risky (italy, greece). US bonds need to be headged, I assume, so I am not sure what the yield on them would be after expenses. Equity is not unlikely to take a deep dive within the next 10 years.

I feel like the best "investment" in this situation for me would be to make sure to avoid the loan in the future. This way I would save about 1,5% interest rate on the loan with a 100% certainty.

Would you agree that this is the right approach? Alternatives? :confused

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arcticpineapplecorp.
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Re: Investing with a 10 year horizon

Post by arcticpineapplecorp. » Sun Apr 08, 2018 1:57 pm

TheoLeo wrote:
Sun Apr 08, 2018 1:53 pm
Since I live in germany the banks give about 0,5% interest on it if you lock it up for 10 years.
Welcome to the group. When you say lock it up do you mean like a CD (certificate of deposit)? If so, in the U.S. you can "lock it up" in a CD for different time periods (6 months, 1 year, 2 years, 3 years, 5 years). The longer the time period you lock it up the higher interest you get. But if interest rates go up, you've locked in at the previous lower rate for a long time. Could you lock it up for a shorter time and just keep rolling it as rates go up over time (not a certainty, but hopefully) to ensure you're not stuck getting low interest in spite of the possibility of rising rates over time?
"Invest we must." -- Jack Bogle | “The purpose of investing is not to simply optimise returns and make yourself rich. The purpose is not to die poor.” -- William Bernstein

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Pajamas
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Re: Investing with a 10 year horizon

Post by Pajamas » Sun Apr 08, 2018 2:02 pm

I would not want to lock up money for ten years for 0.5% return even assuming a slightly negative inflation rate, which you can't. You can't make assumptions about what the market interest rate on a loan will be in ten years, either. I would also be hesitant to commit absolutely to investing in a business ten years out, for that matter. Your situation or the business environment could change significantly over a decade.

The thing that stands out to me in your situation is that you said that the business you intend to invest this money in is low-risk. Based on that, I would invest the money in something of equal or less risk, not more risk, unless you specifically want to take on more risk now and less risk later, which does not seem to be the case.

So something with a fixed rate and a reasonably short time frame (like certificates of deposit of one to three years) or something with a rate that adjusts (like a money market account) would make sense to me so that it can more or less keep pace with current rates until it is time to invest in the business or take a loan at current rates to do so. That would also preserve flexibility.

TheoLeo
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Re: Investing with a 10 year horizon

Post by TheoLeo » Sun Apr 08, 2018 2:24 pm

Thanks for the answers!

By mentioning the 10 year CD (pretty sure that is the equivalent of our "lock up accounts") I just wanted to say, that even with a lock-up-period that long, I won´t get more than 0,5%. Shorter periods pretty much go to 0% interest rate. And since I am not talking about millions, 0-0,5% is negligible I think. Therefore, I would stay in "cash", meaning my normal bank account that is always accessible and that also pays 0% (actually I have to pay fees for it :( ).

True that interest rates for loans might also change significantly in the next ten years. Even more reason to try to avoid loans.

Valuethinker
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Re: Investing with a 10 year horizon

Post by Valuethinker » Mon Apr 09, 2018 11:11 am

TheoLeo wrote:
Sun Apr 08, 2018 2:24 pm
Thanks for the answers!

By mentioning the 10 year CD (pretty sure that is the equivalent of our "lock up accounts") I just wanted to say, that even with a lock-up-period that long, I won´t get more than 0,5%. Shorter periods pretty much go to 0% interest rate. And since I am not talking about millions, 0-0,5% is negligible I think. Therefore, I would stay in "cash", meaning my normal bank account that is always accessible and that also pays 0% (actually I have to pay fees for it :( ).

True that interest rates for loans might also change significantly in the next ten years. Even more reason to try to avoid loans.
You are stuck in the Eurozone problem of low interest rates.

You are correct that a US Treasury bond fund, hedged back into EUR, will produce returns of about the German bund fund of equivalent maturity & duration (bund = Ger govt bond). That's the nature of currency hedging-- the cost is driven by the difference in risk free interest rates between 2 currencies. Other Eurozone govt bonds are not risk free - that's what the higher Italian govt bond yield is telling us, the market things there is a chance of an Italian exit from the Eurozone and a Greek-style restructuring (a small risk of this nightmare scenario, but a risk).

For prudence, you are wise to sit in bank accounts. After all short term bunds pay a negative yield! And to stay within the Eurozone deposit insurance limits, generally (100k per Institution per individual).

If you feel like taking more risk, then empirically a 20% equity/ 80% bond portfolio has had higher return and lower risk than a 100% bond portfolio. Thus your bank deposits are equivalent to bonds. So in the long run, and I stress the long run, you might do better with 20% in a global equity fund, hedged back into EUR. But to do so is also to accept the risk you could lose money.

10 years is a long time, and I would caution you against an excessively conservative portfolio, looking across the piste of all your assets. I know of lots of people who have sat in cash for 30 years, "waiting for the right moment" to invest, and it never came.

However that is separate from a defined cash need in 10 years time, which is what you appear to have. There, the immunized portfolio (i.e. one where the cash flows are matched to the liability in size and timing) is indeed the bank account. It would appear you are taking little downside risk, then, because interest rates are unlikely to fall much further (he says hopefully ;-)).

TheoLeo
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Re: Investing with a 10 year horizon

Post by TheoLeo » Mon Apr 09, 2018 11:56 am

Valuethinker wrote:
Mon Apr 09, 2018 11:11 am

So in the long run, and I stress the long run, you might do better with 20% in a global equity fund, hedged back into EUR.
Thanks for your help! I actually considered to invest 25% of it in an ACWI ETF as the alternative to having 100% in my bank account. This way, I would most likely end up at somewhere between 87,5-150% of my initial investment (100% cash) and with a higher likelyhood of ending up at >100% (empirically).

If I would have to put my guesses into numbers (I hope there is no statistician lurking here...):

Option A) 40% chance to have to take on a loan for 1-12,5% at an unknown interest rate in the future and a 60% chance of making 1-50% extra
Option B) Staying at 100% and avoiding a loan for sure

Most likely it is tomayto, tomahto (as always when I can´t decide).

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arcticpineapplecorp.
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Re: Investing with a 10 year horizon

Post by arcticpineapplecorp. » Mon Apr 09, 2018 12:03 pm

TheoLeo wrote:
Mon Apr 09, 2018 11:56 am
Thanks for your help! I actually considered to invest 25% of it in an ACWI ETF as the alternative to having 100% in my bank account. This way, I would most likely end up at somewhere between 87,5-150% of my initial investment (100% cash) and with a higher likelyhood of ending up at >100% (empirically).

Option A) 40% chance to have to take on a loan for 1-12,5% at an unknown interest rate in the future and a 60% chance of making 1-50% extra
For U.S. investors a comma in the EU represents a "." in the U.S. and a "." in the EU represents a "," so whereas the OP referenced:
87,5-100%. This means 87.5%-100%
and
12,5% means 12.5%.

I thought I'd mention it since those who haven't been in Europe (or outside the U.S.) might not be aware of this.

I just donated blood this morning and the nurse (from a deep south U.S. state originally) asked where I had been last year to screen to see if I was exposed to any foreign viruses, etc. I told her I was in the Czech Republic and she couldn't find it in her list of countries...because she was typing out "Check..." Her only response was "I've never been outside the U.S."

This is why we need geography taught in U.S. schools. Even if you never travel outside the U.S., you still might need to know some things for your job in the U.S.
Last edited by arcticpineapplecorp. on Mon Apr 09, 2018 12:04 pm, edited 1 time in total.
"Invest we must." -- Jack Bogle | “The purpose of investing is not to simply optimise returns and make yourself rich. The purpose is not to die poor.” -- William Bernstein

MotoTrojan
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Re: Investing with a 10 year horizon

Post by MotoTrojan » Mon Apr 09, 2018 12:04 pm

TheoLeo wrote:
Mon Apr 09, 2018 11:56 am
Valuethinker wrote:
Mon Apr 09, 2018 11:11 am

So in the long run, and I stress the long run, you might do better with 20% in a global equity fund, hedged back into EUR.
Thanks for your help! I actually considered to invest 25% of it in an ACWI ETF as the alternative to having 100% in my bank account. This way, I would most likely end up at somewhere between 87,5-150% of my initial investment (100% cash) and with a higher likelyhood of ending up at >100% (empirically).

If I would have to put my guesses into numbers (I hope there is no statistician lurking here...):

Option A) 40% chance to have to take on a loan for 1-12,5% at an unknown interest rate in the future and a 60% chance of making 1-50% extra
Option B) Staying at 100% and avoiding a loan for sure

Most likely it is tomayto, tomahto (as always when I can´t decide).
This plan seems sound to me as long as there is a contingency for any shortcomings. Just make sure you reinvest your dividends, and your odds are pretty good at coming out ahead. As a risk-reduction means you could also consider a relatively large rebalancing band. For example, if the original equity stake grows 25%, you transfer half of the gain to cash. I don't consider this marking timing in your context, as it more closely resembles traditional rebalancing to maintain risk exposure. Just make the bands large enough that it isn't super tedious.

Tal-
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Re: Investing with a 10 year horizon

Post by Tal- » Mon Apr 09, 2018 12:11 pm

This is hard to answer without some additional context:

What happens if it takes you 12 years rather than 10? Or 8 years? Is 10 a magic number?

What are the chances that you will not be able to invest in the business in 10 years (or that you will not want to...)?

What portion of your net worth are we talking about? Excluding this money, how are you doing in terms of progressing towards your other financial goals?

What does your current income/expense/savings look like, and what % of your savings is going towards this purchase in 10 years? Do you have a separate retirement account (not sure what this would look like in EU).

Sorry to pry, but knowing these answer may help provide some context.
Debt is to personal finance as a knife is to cooking.

TheoLeo
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Re: Investing with a 10 year horizon

Post by TheoLeo » Mon Apr 09, 2018 12:50 pm

Tal- wrote:
Mon Apr 09, 2018 12:11 pm
This is hard to answer without some additional context:

What happens if it takes you 12 years rather than 10? Or 8 years? Is 10 a magic number?

What are the chances that you will not be able to invest in the business in 10 years (or that you will not want to...)?

What portion of your net worth are we talking about? Excluding this money, how are you doing in terms of progressing towards your other financial goals?

What does your current income/expense/savings look like, and what % of your savings is going towards this purchase in 10 years? Do you have a separate retirement account (not sure what this would look like in EU).

Sorry to pry, but knowing these answer may help provide some context.
10 years is not a magical number, but this is roughly the typical time for this career step in my profession. Might be 8 years, might be 12 years.
It is very likely that I will pursue this career path and therefore need this money some way or another.

Since I am just starting out with my first real job after getting my degree, it will be my complete net worth (minus an emergebncy fund for about 6 months of expenses). However, around 40% of my income directly goes to a mandatory pension fund, health care insurance, social security etc. I don´t count this as part of my net-worth. But there is a nice safety net due to these contributions. Even if I lose my job after only working for a few months, the state would support me with 60% of my previous salary for half the number of months i worked so far.

And regarding your last question, I save 30% of what is left after taxes, pension, health insurance and social security. So one could say that I save around 20% of my total income for this future investment.

I guess you are asking because you want to know if I am pressed to make as much money as possible. I am not. But if there is a way to make things easier along the way, I take it :greedy

Tal-
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Re: Investing with a 10 year horizon

Post by Tal- » Mon Apr 09, 2018 1:30 pm

TheoLeo wrote:
Mon Apr 09, 2018 12:50 pm
I guess you are asking because you want to know if I am pressed to make as much money as possible. I am not. But if there is a way to make things easier along the way, I take it :greedy
Close, but I was looking at it the exact opposite way. I was starting from the mindset of: 10 years is a long time, and assuming that over 10 years, a conservative stock/bond allocation should speed up your timeline by a year or two. I asked the questions to try and understand: If that standard response is wrong and you lose money over 10 years, will TheoLeo be screwed? :)

It feels like you could stomach a lot of volatility, and even modest 10-year losses and still be in great shape. Insofar that this is true, I'd go with a 50/50 stock/bond portfolio. If that portfolio loses 20% over the next 10 years (crazy, but possible), it would take you 12 years to get to your goal rather than 10. While not ideal, that doesn't sound like an awful outcome.

More realistically, if you generate a modest 4%/year more return, you would either reduce the time needed to get to your goal by 1.5 years, or you would need to save 10%/less per year.

There's no real harm in keeping this money in cash, but my personal take is that investing it in a conservative portfolio is a better option. And if I'm wrong, it doesn't feel like that would too bad :)

It's an interesting question - let us know what you decide.
Debt is to personal finance as a knife is to cooking.

TheoLeo
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Re: Investing with a 10 year horizon

Post by TheoLeo » Mon Apr 09, 2018 3:15 pm

Tal- wrote:
Mon Apr 09, 2018 1:30 pm
It's an interesting question - let us know what you decide.
Compared to 100% Cash/CD, putting 20-50% into global equity would have lots of upside potential and not much downside risk, judging from the past. Thats also what I conclude from playing with portfoliocharts.com. Additionaly I would include the occasional black swan and think of a 90% loss of equity value as possible. Therefore, I wouldn´t want to risk to invest more than 25%. That still leaves me with lots of upside potential and not much downside risk.
However, when I consider that we have had a longer bull run now, I guess the downside/upside potential is a little worse than the historical average, which puts me in the same zone as keeping 100% Cash*. I know that makes me kind of a market timer, but I think it has an empirical foundation.

So....I will keep it in cash/CD and hope the banks won´t charge me more :annoyed

Thanks all for helping me get my thoughts in order! :sharebeer

*Edit: It puts me in the same upside/downside potential bracet as cash, because I have the additional risk of having to take out a loan if I lose money (or postponing the business investment). So while a "stay the course"-investor can just ride it out if she happens to have a negative 10-year return, I will have an even longer negative return because of the loan that follows and because I won´t be invested in equity when the following bull run sets in.

PS: Sorry for the long sentences. My english teacher tried to cure it, but she failed :)

TheoLeo
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Re: Investing with a 10 year horizon

Post by TheoLeo » Mon Apr 09, 2018 3:59 pm

I just read your signature, Tal-: "Debt is to personal finance what a knive is to cooking".

Does that imply that an early investment in equity should, in the long turn, outrun the negative impact of a loan that would have to be taken out with a 10-year delay? So if I would get a negative 10 year return, I would not take any of that money out of equity and would instead get a loan for the full amount.

That would be like leveraging with a 10-year head-start (5 year on average, to be precise) for equity. Any thoughts on that? I Would invest 25% of my income in equity and if it gives a negative 10-year return, I will just let it run and replace the full amount with a loan.

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