Why not put short-term savings in the market?

Question

My income comes entirely at the end of the year so I'm planning out where I should put my expenses for the year. The general advice I've seen is that you shouldn't put money into the stock market if you'll need it within a year or two, but I'm questioning that advice for my personal situation where my savings (mostly in cash and broad index funds) is much greater than my expenses.

I could do one of:

1. put the money in a high interest savings account and get 4.5%
   • no risk
   • slightly faster to access the cash
2. put the money into stocks and get higher returns on average but be exposed to short term fluctuations
   • higher transaction costs (but index ETFs are extremely liquid and stock trading is free)
   • if market goes down
     • I'll have losses
     • I'll sell the dip (i.e. a larger quantity of shares)
     • I'll deduct the capital losses which will help offset other gains
     • I'll still have plenty of savings for the long term
   • if market goes up
     • I'll have gains (but I can sell old tax-lots to avoid short-term gains)
     • I'll pay taxes on the gains

Am I wrong to think the benefits of the market could outweigh the risks? Am I missing some other downside or misunderstanding the costs? I'm guessing the general advice is geared towards risk-averse folks and those with less savings.

Answer 1

It seems that you have a decent grasp of the risk and pitfalls.

If you have a certain amount of money that could lose half its value overnight and then take two to three years to return to its original value then it can be invested. While this is an extreme circumstance it is a decent litmus test.

Another way to approach this is to some money in safe high yield savings, and some invested in the market. If you do 50% in each, then even if the market does lose half its value you still have 75% of your savings.

Please considering looking into bonds to boost your "safe" earnings rate. Shorter term corporate bonds are returning well over 6%. Currently I am pretty active in this area.

Answer 2

So based on some comments above I've gotten some ideas:

• just crossing the bid-ask spread could easily reach .5% which rules out any strategy involving holding for very short periods
• based on my naive and simplistic spreadsheet backtesting just looking at SPX over the last 5 years, which for better or for worse contains the 2020 COVID roller coaster:
  • for 1 month holding periods, 32% had negative nominal returns, the worst was -49% return and the mean was .9% (11.1% annualized)
  • for 3 month holding periods, 32% had negative nominal returns, the worst was -28% return and the mean was 3.6% (14.3% annualized)
  • for 6 month holding periods, 28% had negative nominal returns, the worst was -25% return and the mean was 7.4% (14.8% annualized)
  • for 9 month holding periods, 29% had negative nominal returns, the worst was -21% return and the mean was 11.6% (15.5% annualized)

So my conclusion is that these are all pretty risky in that they have a good chance of being significantly negative. On the other hand all the typical returns are way above the best high-interest savings account.

I'm still pretty unsure if I'm missing any other factors.