We’ve all heard one form or other of the following bit of financial advice: “You should only invest in the stock market if you are going to leave your money in it for a long time.”
It sounds sensible, but it is utter nonsense. You don’t need to know anything about finance, or about math, to see that it is nonsense.
Consider a slightly more specific statement of this advice “If you have a certain sum of money you are considering investing, you should invest it in the stock market if and only if you plan to leave it there for more than 5 years.” (You can find an example of this advice here, if you replace “5 years” with “10 years.” In this instance the advice is given by the founder of the Vanguard Group, who should know better. Here is another instance.).
To see that it is nonsense, consider it in the context of a short screenplay which I have written about the interaction between an investor and his foolish financial advisor:
The year is 2011. The investor walks into his financial advisor’s office.
Investor: Hi. I have just won $10,000 in the lottery. Should I invest it in the stock market, or should I put it in a savings account?
Advisor: It depends on when you plan to spend the money. You should put it in the stock market if and only if you plan to take it out of the market more than 5 years from now.
Investor: I plan to spend it in 7 years, in 2018. I’m going to buy a house at that time.
Advisor: Ok, then, since 7 > 5, you should invest that money in the stock market.
Investor: Great, thanks!
3 years pass. The investor walks back into his advisor’s office to discuss his finances.
Investor: Hi. I want to check up and make sure I am doing the right thing with my money. 3 years ago you told me to invest $10,000 in the stock market, and I followed your advice. Should I leave it there?
Advisor: When do you plan to spend it?
Investor: I plan to spend it in 2018, as I told you 3 years ago.
Advisor: That is only 4 years from now. Since you should only invest money in the stock market if you plan to leave it there for more than 5 years, and since 4 < 5, you should pull your money out of the stock market. (Neglecting taxes and transaction fees, your decision about whether to keep your money in the stock market is equivalent to the decision about whether to put into the stock market money which is not currently in the stock market. Since you shouldn’t do the latter with only 4 years to go, you shouldn’t do the former.)
Investor: But that doesn’t make any sense! You originally suggested I should invest my money in the stock market for 7 years. Why are we abandoning your plan midstream?
Advisor: We are just re-applying the same advice I originally gave you, which is that you should only have money invested in the stock market if you plan to leave it there for more than 5 years.
Investor: But that advice clearly doesn’t work! 3 years ago, that advice suggested I should leave my money in the stock market for 7 years, and now it suggests that I should pull it out after only 3. It seems to me that as long as we are living in a universe in which time passes, rather than standing still, your advice is self-contradictory.
Advisor: I don’t get it.
Investor: You’re fired.