What are the downsides to short term investments

JimmyTheWig

atush wrote: »

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.

Are you saying that when I need my £5k, my £20k may have become £3k? I understand that that is possible, but so very unlikely with a broad range of investments.
Or are you saying that when I need my £5k, my £5k may have become £3k? If that's the case then I'd use my long term investments to back it up.

eskbanker

badger09 wrote: »

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"

Not many posts on here quoting Will Young, perhaps someone will be along recommending another musical mantra from a somewhat different genre: "You know I'm born to lose, and gambling's for fools, But that's the way I like it baby, I don't wanna live for ever"

Linton

JimmyTheWig wrote: »

Are you saying that when I need my £5k, my £20k may have become £3k? I understand that that is possible, but so very unlikely with a broad range of investments.
Or are you saying that when I need my £5k, my £5k may have become £3k? If that's the case then I'd use my long term investments to back it up.

Yes but your long term investment would also have presumably dropped by 40% and so taking the missing £2K from these investments would have cost you £3333 of your original £15K long term funds.

The key problem I find with your reasoning is that markets tend to rise much more slowly than they fall. They will eventually rise to a higher level than before a fall, but this takes time. With your 5 year term you are unlikely to be able to recover from a major fall. In these circumstances average returns become pretty meaningless. You are only playing this game once, so you cannot take advantage of them.

Pincher

There is this myth that the stock market is the place to make easy money. I would like to think that it's a gambling den that chucks you out when you're cleaned out.

At least Atlantic City gives you a free return bus ticket to make sure you can get home alright: a cheap day out to the beach, by the way, on slow days you could even get a buffet voucher, so lunch is taken care of.

I have lost less money in Atlantic City and Vegas combined than on the stock marlet. In fact, on the border between California and Nevada, there was this lonely casino/hotel, possibly an Indian reservation type set up,where I was quids up. Hotel room for $25, meal for about $30, and then made $100 on something I can't remember. Drove out the next day about $40 better off. Never been like that on the stock market.

AlanP_2

Pincher wrote: »

There is this myth that the stock market is the place to make easy money. I would like to think that it's a gambling den that chucks you out when you're cleaned out.

At least Atlantic City gives you a free return bus ticket to make sure you can get home alright: a cheap day out to the beach, by the way, on slow days you could even get a buffet voucher, so lunch is taken care of.

I have lost less money in Atlantic City and Vegas combined than on the stock marlet. In fact, on the border between California and Nevada, there was this lonely casino/hotel, possibly an Indian reservation type set up,where I was quids up. Hotel room for $25, meal for about $30, and then made $100 on something I can't remember. Drove out the next day about $40 better off. Never been like that on the stock market.

Were The Eagles playing live in the bar?

bigadaj

eskbanker wrote: »

Not many posts on here quoting Will Young, perhaps someone will be along recommending another musical mantra from a somewhat different genre: "You know I'm born to lose, and gambling's for fools, But that's the way I like it baby, I don't wanna live for ever"

Don't think I'd be looking to get financial advice from lemmy or will young though.

JimmyTheWig

Linton wrote: »

In these circumstances average returns become pretty meaningless. You are only playing this game once, so you cannot take advantage of them.

If it is the right strategy then no reason for me not to play many times over the rest of my lifetime.
I think that average returns is exactly what it's all about, given that the money I need is underwritten.

princeofpounds

Time horizon is important because with time the volatility of outcomes is much smaller. Check the link below for an illustration - it's Canadian but the principle is the same.


http://www.getsmarteraboutmoney.ca/en/tools_and_calculators/infographics/Documents/infographic-How-time-horizon-affects-risk-and-return.pdf


If you are investing over short time horizons, the outcome is dominated by the 'random' volatility, whereas over the long term, the outcome is dominated by the compounding shareholder value generated by the underlying assets.


If you think about it in terms of roulette - on any given spin, it could be red or black - an extreme outcome of 100%/0% in favour of one colour. But after a number of spins, the statistical 50/50 average would assert itself, and with a thousand spins you would almost always get something more like 50.1%/49.9% red/black. Those extreme events get diluted in importance over time.


In fact with stocks, it's a little bit more powerful than that because there is a tendency to mean-revert. With roulette, each spin is independent of the other. With stocks, a period of excessive outperformance or underperformance makes it harder to duplicate over the following periods.


There are some sophisticated discussions about how exactly is best to view stocks in the ultra long term, but the basic mechanism here certainly holds just as a mathematical outcome.


I think another thing that is also important to understand is that people very often think about investing at one point in time and then selling that investment at another point in time in the future. But in reality most people are constantly investing in a drip feed over their lifetimes (and reinvesting dividends). So if you keep buying at high and low points in the cycle then the cycle itself becomes much less dangerous to you. It is often exactly the point when you realise your investments have done nothing for 5 years that you need to keep buying, but unfortunately that is often the point when people give up.

princeofpounds

JimmyTheWig wrote: »

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"?

I just wanted to return to your original question.


In your example, you are essentially giving yourself a financial cushion. Your expected outcome two years out NEEDS to be 5k, but you given yourself a starting position of 20k.


So of course it is not going to feel like a total failure if the negative scenario materialises.


The outcome is still vastly dominated by volatility, the given the short time horizon. But the range of outcomes are shifted upwards by your 20k starting point.


It is a perfectly possible strategy to take a view on the extremes of such volatility and invest as you have described. You don't have to keep everything for short term use in cash, if you are wealthy enough to bear the risk.


But you should realise that this strategy does mean that you are taking more risk, because you are taking more market exposure. To do some maths, using your 75% downside case:


20k invested in stocks = 5k bottom boundary
15k invested in stocks and 5k in cash = 8.75k bottom boundary.


Both cases are still perfectly 'safe' for your 2 year goal of 5k. But the first still has a wider range of outcomes.

grey_gym_sock

JimmyTheWig wrote: »

For a larger expected gain.

i agree there is a larger expected gain. the downside is that the worst case scenario becomes worse.

i think it's implausible that most ppl should simply be going for the highest expected gains. ppl who have far more wealth than they plan to spend might well choose to do that - think of warren buffett, who is presumably trying to maximize the amount he will be able to leave to charity. this also applies to ppl with much less wealth but who are frugal enough to live far below their means.

but for most ppl, the worst case scenarios do matter. making sure (or as sure as you can) that you won't struggle to get by in retirement probably matters more to you than whether you will be able to take that third luxury cruise per year.

IMHO, the whole idea of expecting ppl to invest for the bulk of their retirement income is fraught with difficulty, because of the unpredictability of investment returns. in order to be at all confident that you will have enough in the worst case, you have to put away vastly more money than you will need in the best case. it would be better to go back to something like SERPS - i.e. instead of investing, and in return for tax/NI on earnings, to have the state pay a known, index-linked, earnings-related pension. (there has of course been a huge amount of propaganda claiming that the state can't afford this, is about to go bust, etc, but that is essentially rubbish.)