Where is the boundary between short and long term investment?

Question

It's well known that it's impossible to time the market and therefore short term investment is usually not a good idea for occasional investor. At the same time, long term investment is almost always profitable. Now, where is that boundary between short and long term? I do understand that it's not as clearcut, but some guidance would be useful.

In my specific case, out of my savings, there's about £25-30K chunk that I don't immediately need, yet it's sitting in a savings account earning a near-zero interest. I will need this money in about 3-4 years time - and I can't afford to "loose it all", although I can risk a small hit (up to 5%) - of course, I want to maximise the return. I also have little flexibility about stretching this time period (maybe to 5 years, but not more). I'm trying to come up with the best strategy to make this money work.

Note, this money is not my "emergency fund" (that one is different and sufficiently funded).

Answer 1

You're right, there's not a strong line between "short-term" and "long-term" other than for taxes, where 1-year distinguishes between short-term and long-term capital gains.

What you really want to know is "what are the chances that I'll lose more than 5% in 3 years if I invest in X", which is not a simple answer.

If you want to use history as a guide, you could look at every 3-year period of the market you want to invest in, and see how many times that market has lost more than 5%.

For the S&P 500 (a US Large-cap stock index) that percentage is about 10% based on my data (9 out of 92 years) with an average 3-year return of about 38%, and a maximum 3-year return of over 100% (back in 1995-1997). The longer the time period you look at, the lower the odds of losing, but the lower the expected return. For 5 years the odds of losing more than 5% go down to about 6%, but the average annual return drops from 10.6% to 10.15%.

So you can decide if getting an average return of 38% is worth a 10% change of losing more than 5%. If not, then you can mix in some safer investments (like bond funds) that will reduce the odds of losing but will also reduce the expected return.