The Vital Distinction That No One Is Talking About

When people think about making an investment, they usually fail to consider one of the most important aspects associated with investing.

You see, every asset exists on a spectrum of access: some are easier to liquidate than others. It is far easier to move funds in a regular savings account as opposed to a fixed-term savings account; the former requiring a few clicks of a button, the latter potentially requiring legal action (and even then – you might still fail).

Why is this important?

The ease of liquidation of assets within an investment vehicle has an influence over what strategies can and should be used within that vehicle. Because assets that are easy to liquidate and funds that are easy to access have some degree of uncertainty about the investment horizon attached to them.

Let’s return to our two savings accounts. Imagine you are saving up for a holiday to Sorrento (which will inevitably be cancelled due to Covid) in the summer. In one scenario you put money aside in a 6-month fixed-term savings account, with the funds being accessible on July 6th, 4 days before your EasyJet flight from Luton Airport. What’s the probability of your funds being there before your trip? Barring some type of aggressive customer complaint or legal action, it’s pretty much guaranteed. 

Now imagine a parallel universe in which you instead decided to save the GBP equivalent of the EUR required to purchase ice creams and pizzas and limoncello. I ask again – what’s the probability of your funds being there before your trip? Nowhere near guaranteed. Shit can and certainly does happen – your roof will start leaking, your car will need repairs, your youngest child will lock themselves in their room and go on a hunger strike unless they get the new PS8. The funds earmarked for Italy in your head may have to be used for something else.

The above example may seem silly but the same thing can happen in much higher-stakes , asset-involved scenarios. Imagine now that you’re not saving for a holiday but the permanent holiday better known as retirement. Doing this by utilising a pension and doing this in an accessible investment account are different ball games. In fact, they’re not even the same sport; the former requires 0 liquidation discipline whereas the second requires huuuuge amounts. Think about it: how many times between the ages of 20 and 60 do you think you would be tempted to use some of your retirement fund for something which seemed vital at the time but 60-year-old you would travel back in time and slap the younger you in the face for even considering. When your assets are available, this type of short-termist stupidity is an option.

Liquefiable assets are accompanied by a stochastic investment horizon.

Timeline becomes a random variable – something that must be taken into account of when making investment decisions. This is one thing that I see those distributing (naive) financial advice get wrong; using the same simple investment strategy across all investment vehicles is simply overly simplistic. “Just invest!” – the situation is slightly more nuanced than that. One should not be using the same allocation for a pension, an ISA, a LISA, a regular investment account, etc. When are you going to buy a house? When are you going to need that ISA money? When can you liquidate your pension fund? Only one of these questions has a (nearly) guaranteed answer.

Don’t give me problems, give me solutions

The most obvious solution to this problem is to use different strategies for different investment vehicles.

If the liquidation date of a portfolio is completely unknown, one must invest in assets that maximise the probability of real return regardless of liquidation date. Whereas, if the investment horizon is more certain, one can afford to tailor the strategy for that investment horizon. This can result in very different allocations. If I had to choose a portfolio that could be liquidated in 3 months time, I would hold a significant amount of cash. A portfolio liquidated in 3 decades time would probably include no cash.

Of course, if one were to have more money than one knew what to do with, the probability of necessary liquidation is pretty low. I wouldn’t need to sell some of the assets in my ISA to pay off my (ridiculously high) electricity bill if I had £10M sitting in my Santander account.

Even this isn’t full-proof. Even if you’re a billionairé, one day you may decide you’re bored and want to go to space and need a few billy to do so.

But personal finance quote-unquote “gurus” would argue that this is a known phenomenon. 

“Just part of the game”

“Price of admission”

“It is what it is”

Y.O.U are the problem – if you don’t have the required discipline to stick to an investment strategy, you shouldn’t be investing in the first place. They would say. And, in fairness, this does fix the problem: if you actually never liquidate the assets in your Vanguard General account then your strategy can be the same as that in your pension fund. This can also be helped by implementing things like incentives not to sell, FU attitude, and specific goals that you reaaaally want to hit. 

The less likely you are to need the money, the more incentives you have not to sell, the greater your desire for whatever goal you are investing for, the more disciplined you are, the less likely you are to sell prematurely.

But, wait, pause, stop. Hold on. It takes serial-killer-level discipline to never sell. If your sister is in need of an urgent, expensive medical procedure, I hope you would sell to cover this expense, even if it isn’t part of your financial plan.

I suppose some would argue that the probability of needing to sell is so negligible as to be practically equivalent to 0. And this may be true in some circumstances. But if we’re talking about long time horizons and relatively large amounts of money, this is simply not the case.