Six tips for short-term investors

Short-term investors with a five to 10-year investment window need a different strategy to long-term investors.

Successful investing, as we’re often reminded, is all about time in the market rather than timing the market – and ideally, that means decades rather than just a few years.

But there are times when your timescale is tighter and less flexible, perhaps because you’re saving for your child’s schooling, or your planned retirement date is approaching. Investing is still a viable option, although the consensus is that you do need at least a five-year horizon to ensure your capital has time to recover from early market setbacks.

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The principle of a long-term approach is simple: there are bound to be short-term ups and downs, but over the years a well-managed portfolio of shares or funds will ride out the volatility and grow.

Take, for example, a tracker following the UK’s FTSE 250 index of medium-sized companies. Over the past turbulent year, the index is down 24% (to 18 October). But since launch more than 25 years ago it has grown by almost 300%, despite the impact of the tech bubble, financial crisis, Covid and 2022’s market rout.

Clearly, there are inherent risks to investing in the markets, especially when they are as volatile as they are at the moment. But if you have a specific goal down the line then you need your money to be growing, and ideally to be outpacing inflation over the medium term. And that should be manageable over a five to 10-year perspective.

So, with a view to reducing volatility and maximising real returns, what should you bear in mind?

1) Opportunity knocks

First, ongoing market turbulence may alarm or depress investors, but it is also providing great longer-term opportunities. That’s especially true for investors just starting out on their portfolio-building journey, who are in a position to pick up high-quality investments at bargain prices.

Ben Yearsley, investment director at Shore Financial Planning, puts this strategy into perspective: “Even though it’s nerve-wracking, I’d rather invest when no one else is, as it should mean prices are lower. It’s risky in the short term, as prices are currently volatile and could easily fall 10% in a short space of time; but if you are investing for five to 10 years that shouldn’t matter.”

2) Diversification is key

As Gavin Haynes, investment consultant at Fairview Investing, points out: “Second-guessing what will be the best market or asset class is difficult at the best of times, and even trickier in the current global economic uncertainty,” so a good mix of investments is an obvious solution.

Some countries have been harder hit than others by inflation, the war in Ukraine and global slowdown: for instance, India was recently highlighted by the IMF as “a bright spot on a dark horizon”.

So geographical diversification is clearly important, but make sure you also spread your resources across large and small-cap equities, different fund manager investment styles (growth and value), and a range of asset classes.

Yearsley highlights particularly the danger of focusing exclusively on one investment style, even with other types of diversification: “Taking Bailie Gifford as an example, many thought that because they had lots of growth-focused Baillie Gifford funds investing in different geographies, they therefore had diversity; but the crucial thing was that these funds were all invested in the same way.” When growth fell out of favour earlier this year, Baillie Gifford’s whole stable was hard hit.

3) Cautious choices and capital preservation

A quick fix for instant diversification is to use a multi-asset fund as a core part of your portfolio. These hold a mix of bonds, equities and in some cases various other assets, with the asset allocation, selection and monitoring left in the hands of the fund manager.

In the current climate, Haynes suggests that cautiously run funds and investment trusts with a strong focus on capital preservation may appeal to relatively short-term investors. These hold a broad range of assets and aim for positive absolute returns, regardless of market ups and downs. 

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He picks out LF Ruffer Diversified Return (BMWLQT5) fund (or Ruffer Investment Company (LSE:RICA), run by the same team) and Troy Trojan fund (or Personal Assets (LSE:PNL) trust, again run by the same manager as its sister open-ended fund) as particularly strong performers this year. Other highly regarded investment trust names (most are investment trusts) include Capital Gearing (LSE:CGT) and RIT Capital Partners (LSE:RCP).

4) Tap into the power of compounding

“Even if you are an investor seeking growth, you should not ignore income-producing investments, especially as falling share prices have resulted in dividend yields rising,” continues Haynes. The beauty of dividend payers such as UK and global equity income funds is that the dividend compensates for short-term capital falls.

Moreover, reinvesting income to buy more units means that those units in turn produce an income payment, which itself can be reinvested, and so on. That’s the compounding process, and it is a powerful tool for any investor.

A core UK equity income fund investing in UK blue-chip dividend stocks (Haynes suggests FTF Martin Currie UK Equity Income) currently yields around 5%.

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Investment trusts also offer a way into the equity income arena. These are ‘closed-ended’ investments where a fixed number of shares are in circulation and are traded on the stock market (unlike ‘open-ended’ funds where the number of units fluctuates with investor demand).

So, in difficult times even a high-quality trust’s share price can be trading at a discount to the value of the assets it’s invested in. As circumstances improve and there’s more demand for shares, the share price may rise and the discount narrow, providing an extra boost in returns for investors who bought cheaply. But there’s no guarantee that will happen any time soon.

Examples include Murray Income Trust (LSE:MUT) on a 4.8% yield and a 5.3% discount, and Edinburgh Investment (LSE:EDIN) trust, yielding 4.1% and trading on a 1% discount.

5) Fixed interest centre stage  

After well over a decade of cheap money and very low bond yields, this year has seen increasing chaos in global bond markets in the face of aggressive interest rate rises. And there are fears of more to come, as central banks continue to try and put the screws on inflation.

The UK bond market has lost around 25% this year and yields on ‘risk-free’ 10-year gilts have risen to almost 4%. Yields among corporate bonds are greater because of the additional risk of default.

It all stacks up to the best opportunity for many years for investors to take advantage of the reliable income and relatively low volatility offered by fixed interest holdings. But Sim Liddle, director at Church House Investment Management, argues that it makes sense to stick with short duration bonds (those maturing within the next two to five years).

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“Two-year gilts are paying 3.6% compared with 3.9% for 10-year gilts, so it’s not a colossal difference in yield, but there’s an awful lot more uncertainty and volatility attached to longer duration,” he explains. He also advises sticking to high-quality corporate bonds from big, robust companies such as banks, given the current gloomy recession.

For a diversified approach to fixed interest exposure, Haynes suggests that a fund such as Janus Henderson Strategic Bond could be worth considering.

6) Cash savings accounts

The big plus with cash is that your capital is not at risk. Moreover, for the first time in 13 years it is possible to earn a decent return, as rising interest rates have spawned a rush of relatively attractive easy access and fixed-term accounts.

Yearsley advises sticking to one-year bonds and keeping six to 12 months of living costs easily accessible. JN Bank currently pays a top rate of 4.75% on a one-year fix, with many others paying upwards of 3%.

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That’s a safe bet and a massive improvement on recent years. But bear in mind that with consumer prices index (CPI) inflation at 10.1% in September and expected to remain elevated in 2023, you’re set to lose money in terms of purchasing power, so this should be part of a broader mix of assets.