Wait, wait I need the money in 10 years

A classic recommendation is to hold your investments in a money market fund or similar if you need the money in the short term. I agree with this in principle. However, I fear that we tend to define “short term” too broadly. Is short term one year, two years, five years, or even ten years?

I acknowledge that if you need $50k for an expected expense next year, you should keep it in cash for that event. But beyond that timeframe, keeping cash under your mattress is a sure way to lose purchasing power. If effectively lose you money! Inflation will grind away that $50k. At 2% inflation, that is a $1k loss per year. You should instead invest it instead!

Be wary of putting money into a bond fund! These can produces negative returns. For example, bonds lost 11% in 2022. Even short-term bonds lost 9% in 1946. In many case, bonds often do not beat inflation. Historically, bonds failed to outperform inflation about 33% of the time. See the Historical return Tool.

Why do you need the money. If the reason is a large expense such as a house, why do you need an exact amount? In five years, do you already know the required value after negotiations for what you will buy? Do you have flexibility in the amount of home equity you will contribute?

Say you have $50k today. Would you absolutely need the full $50k, or would a worse-case scenario of $40k simply result in a few thousand dollars more in insurance costs?

If you are in the market for buying a house, I have compiled the average house prices in Montreal, Toronto, and Vancouver over the past 25 years and compared it to a $50k investment

$50k was worth 20% of the average 200k home in 2000. The housing gone crazy, ten years later (2010), $50k represented only 10% of the average house price of 500k. By 2025, only 5% of the million dollar average house  value.  

Obviously that's an extreme example, but it illustrates that keeping money under your mattress is not a good strategy. Instead, if we plan to wait for a short term before buying an item, we need to invest!

Let’s compare a few asset allocations. Before accounting for inflation, 100% short-term bonds will generally make your money grow. After inflation, however, they do not keep up with rising prices. A portfolio invested entirely in the broader bond universe performs slightly better.

Next, let’s compare this with a full equity portfolio (50% U.S. / 50% Canadian equities), which is notorious for producing the highest returns, but also the worst outcomes. Finally, let’s compare a portfolio with a touch of gold (25% gold, 40% equities, 35% bonds), aka the golden portfolio. This last allocation performs much better than the classic 40% bonds / 60% equities or 60B/40E alternatives.

Here's some graph comparing after 2/5/10 years of investing $50k (all results net of inflation).

After 2 Years:  

At worst, none of the portfolios managed to preserve the full $50k. However, keeping money under your mattress would eroded your purchasing power to roughly $39k.

Note that during 1930–1933, inflation was negative, which explains why purchasing power sometimes increased when money was kept under the mattress.

Looking at the worst 10th percentile and 5th percentile outcomes, the “golden portfolio” shines by preserving more value than its peers. If your priority is preserving 95% or more of your money, the golden portfolio appears to be the best option.

Over 50% of the time, however, the all-equity portfolio performs best by a large margin — almost 10% more than its closest competitor. In the 25th percentile worst-case scenario, the best result comes from the 40% bonds / 60% equities portfolio, but the all-equity portfolio trails by only about 3%.

For me, it is clear that 75% of the time the all-equity portfolio is the best option. However, during the worst periods, it compares negatively, performing roughly 10%–25% worse than the golden portfolio alternative. 

After 5 Years:  

After five years, we notice that keeping money under the mattress is the worst of  all! Really, if you need money within 5 years, keeping it in cash is not a good idea. Anything else is better. 

• The 100% bonds is only slightly better than the all equity portfolio. comparing their worst 5th percentile, perserving only keep 3% more value. During the other 95% of periods, the all equity portfolio performs better.   
• If you desire maximum safety, then the golden portfolio will most likely let you keep most of it. 
• If you want a chance to grow it, than the all equity  portfolio grant more than 75% chance of growing it. At worst, the all equity portfolio would lose 30% after five years. You would still have beaten the strategy of keeping it under the mattress. 

After 10 Years:  

After ten years, even the worst all-equity portfolio outcome outperforms the median inflation-adjusted result of keeping money under the mattress.

At this point, the real competition is between the golden portfolio and the 100% equity. At the 25th percentile, 100% equity portfolio is 89% of the golden portfolio’s value. However at the median, the golden portfolio achieves only about 86% of the value of the 100% equity portfolio.

Looking further, even at the 20-year mark, similar results are observed. Only at the 25-year mark does the 100% equity portfolio equal the golden portfolio even at the 5th percentile outcome and making the all equity portfolio shines at last under all metric.