Equity is an unpredictable asset class. It doesn’t give returns you want, when you want. It is also terribly difficult to predict equity returns in the short term. Therefore, when time horizon of the investment is less than 5 years, many advisers recommend investors to keep majority of their money parked in debt and not in equity. Equity is not even considered an option when investment horizon is less than a year, whatever be the market condition.
But this concept is difficult to understand for most investors. The lure of return governs all their investment decisions. Even when they want to park their money only for a few months, they want a fund that has generated highest return in the recent past. Good advisers do their best not let their clients commit mistake of parking short term money into equity since bad sequence of return can cause immense harm to this money. Most clients reluctantly agree to do as advised.
The problem begins here. After investments are made (in debt), if equity markets are muted or in bearish trend , clients don’t recognize the blunder adviser helped them avoid. But if equity performs and gives good return, they start thinking that it was mistake to park money in debt instead of equity. They think that they made loss by listening to the adviser, because had they listened to their own good senses, they would have made more money in equity. In cases like these, investors also voice their frustration to advisers telling them that their conservative approach has costed them money.
Investors need to understand that investing is about future and future is both uncertain and unpredictable. While making investment decisions we never know how exactly the future will pan out. Once event has happened we all have benefit of hindsight and all investment decisions look easy when seen in the hindsight. And therefore advisers appear stupid and incompetent when equity performs in the short term while they make investors keep their short-term money in debt.
Since equity is an unreliable asset class in the short term, a prudent investor should avoid putting short term money into equity that lacks staying power. Short term money lacking the staying power is never there to be deployed in equity in the first place and therefore even if equity performs, this money is never going to get benefited from of it. If investors can understand this practicality of investing, it can save them lot of heartburn due to the feeling of being missed out.