What are the downsides to short term investments

JimmyTheWig

Hi,

I know the golden rule.
If you're not prepared to lock your money away for 5-10+ years then you shouldn't invest.

But what are the reasons for this?
Obviously there's the reason that markets can fall in the short term and there's more chance of getting back less than you put in if you take it out soon.
But is that it?

I'm thinking along the following lines...
£15,000 in a S&S ISA, not needed for 20+ years
£5,000 in a savings account, needed in 2 years
What if I moved the £5k into the ISA?

With 6% growth, my £20,000 will become £22,472 in two years time. I take out the £5k that I need and I'm winning.
Say there's a crash and rather than 6% growth I get a 50% loss across the two years. My balance would have dropped to £10,000. I can still take out the £5k that I need and I'm not bankrupt.
Obviously there's nothing to say that there won't be a >75% crash and I won't have £5k left in the ISA, but the chances of that happening are not worth worrying about (are they?).

In effect I'm underwriting the £5k short term investment with the £15k long term investment.
So does this mean that my expected value is greater if I put the money in the ISA for two years than if I don't?
Or is there more to the "don't invest for short timescales" than "what if the investments go down"?

Al.

In effect, you want to capitalise on the compounding effect of a larger sum? This is boring, but if that £5000 is your emergency fund, leave it where it is. It's not just the growth, it's liquidity and access that are important.

Five years is the minimum really, for an economic cycle to run its course, ideally longer. 20 years is perfect. the problem is, currently, all bets are off. We're not seeing asset class correlation as we might expect to see. The drag.. well, that's going to be interesting.

Plus

Over the long term, on past average, markets go up. The trouble is, the shorter the timescale you take the less likely they are to go up within the time period you picked. So, over a shorter period, there is a greater risk that you will lose money.

That doesn't mean to say you can't invest over short time periods, but you should do so being aware that you're upping your risk. One method, for instance, is to extend your investment horizon depending on performance. Let's say you want to buy a Ferrari at some point, but you don't mind exactly when. You could invest now, and cash in in 5 years time if the going is good. Or you could cash in in 10 years time if it isn't after 5 years. You don't have to fix your time horizon at the beginning. Though of course some dates are fixed (for example, children's school fees).

The question is then "how long is 'long enough'"? On past events it's been 5-10 years. There is always the possibility that things will be different next time. But 'different next time' happens less often than people predict.

grey_gym_sock

basically, if you invest an extra £5k, and it falls 50% but will recover eventually, and you pull out £5k from the market without waiting for the recovery, then you've suffered a permanent loss of £5k because you couldn't wait for the recovery.

so is it necessarily a bad idea to invest the extra £5k?

1 argument against doing it is the psychological 1, that it will hurt to lose the money in the worst case, and that it may put you off investing in general.

another argument is that relying on stock market returns is very unreliable anyway, and adding a bit of short-term investing on top of that makes it even worse. we may be broadly confident that shares will do OK over 20 years, compared to the alternatives, but we still have no idea what the returns over 20 years will be. the final sum you might get after 20 years could easily vary by a factor of at least 2. why make this problem even worse?

Al.

grey_gym_sock wrote: »

basically, if you invest an extra £5k, and it falls 50% but will recover eventually, and you pull out £5k from the market without waiting for the recovery, then you've suffered a permanent loss of £5k because you couldn't wait for the recovery.

so is it necessarily a bad idea to invest the extra £5k?

1 argument against doing it is the psychological 1, that it will hurt to lose the money in the worst case, and that it may put you off investing in general.

another argument is that relying on stock market returns is very unreliable anyway, and adding a bit of short-term investing on top of that makes it even worse. we may be broadly confident that shares will do OK over 20 years, compared to the alternatives, but we still have no idea what the returns over 20 years will be. the final sum you might get after 20 years could easily vary by a factor of at least 2. why make this problem even worse?

If you wait for it to recover £5,000, you're still 'down' because you've also lost the value that time gives you. If you lose £10,000 in a mythical nightmare scenario, and then recover £11,000 over the next 12 months, you're broadly only similar to being back where you were at outset. And that means too, that you're 'behind'.

JimmyTheWig

grey_gym_sock wrote: »

why make this problem even worse?

For a larger expected gain.

Pincher

The whole thing is very fishy.

I seem to just lose my bait all the time and never catch a big fish.

Bought some Alliance and Leicester shares for £1,500, which were force converted into Santander shares when they bought it. Held for seven years, and sold for £500. The 8% dividend got all swallowed up by the quarterly account fees.

Nibble, nibble, nibble.

badger09

Pincher wrote: »

The whole thing is very fishy.

I seem to just lose my bait all the time and never catch a big fish.

Bought some Alliance and Leicester shares for £1,500, which were force converted into Santander shares when they bought it. Held for seven years, and sold for £500. The 8% dividend got all swallowed up by the quarterly account fees.

Nibble, nibble, nibble.

That experience, and I have had similar many years ago tells me I'm not able to pick individual winners.

So instead, I invest in a broad range of companies, engaged in a broad range of activities, operating in a broad range of geographical & economic areas. That way, in the words of one of my favourite Will Young songs "I'm a little more careful, perhaps it shows, but if I lose the highs, at least I'm spared the lows"

atush

You could lose your 5K, and you could need the 5K and have to take it out when it is work 3K.

So keep your emergency cash in cash. But earning interest, like in a good current acct.

Archi_Bald

badger09 wrote: »

That experience, and I have had similar many years ago tells me I'm not able to pick individual winners.

Very few people, if any, are. You generally only hear people bragging about the magnificent successes they had. Very few do own up to their losers. Some even manage to brag about their winners when, bottom line, they have lost money due to some duds they had picked alongisde their winners.

That is very typical behaviour for recreational gamblers, which is what, in effect, private investors in individual shares mostly are. Admitting to not being successful at share picking and investing in funds instead is the start to better financial health. The sad truth is that many of us, me included, have to burn our fingers first before we believe it.

JimmyTheWig

badger09 wrote: »

So instead, I invest in a broad range of companies, engaged in a broad range of activities, operating in a broad range of geographical & economic areas. That way, in the words of one of my favourite Will Young songs "I'm a little more careful, perhaps it shows, but if I lose the highs, at least I'm spared the lows"

Sorry to get mathematical, but by investing in a range of companies rather than a single company you lower your standard deviation, but your expected value stays the same. So it's a no-brainer to do this unless you know better than the market what an individual company is going to do.

But my suggestion (short term investments with the cash guaranteed by long term investments), I believe, increases the expected value.