Price volatility is part of the game in the world of financial markets, and it has increased in intensity in recent years amid the speed of information sharing and connectivity of global economies. Economies and financial markets work in ‘cycles’ to mean-revert over the longer term. Long term investors, at times, feel proud of taking advantage of opportunities that arise from market cycles which many short-term investors do not have the leverage to take benefit from. They can ride-off the short-term swings of the market and the likelihood of making a loss decreases significantly as they move longer on the time horizon ladder.
As demonstrated in the following graph, the likelihood of a loss decreases as the investment time horizon goes up – the likelihood of a loss for 1-year is 25% compared to 6% for 10-year time horizon. Other research studies show that the probability of loss is almost negligible for 20-year investment time horizon.
What ‘long-term’ means in long-term investing
Long-term investing is a game of patience to allow investment assets to deal with the market volatility and generate positive alpha. However, there is no standardised definition of long-term investing. Generally, any investment view which is less than one year is considered a short-term investing, investment view of up to three years is considered as a medium-term investing, and investment view of more than three years (probably five-to-ten years) is best known as long-term investing.
At Simply Ethical, we believe for most stock market investors a minimum of 5-years’ time horizon is prudent. This is because it is quite normal for the financial markets to remain stressed for few years during times of economic recessions. Financial assets need a good amount of time to get the investors’ confidence back and recover from the losses.
Long-term investing and probability of positive returns
Long-term investing increases the probability of alpha (positive returns). The effects of volatility average-out over the long-term as businesses grow and innovate. As shown below, the probability of positive returns is 70% for one year investment horizon, which increase to 90% for five year and 95% for ten-year investment horizon. This affirms the importance of long-term investing for investors with great deal of patience.
Probability of making losses decreases as investment time horizon increases
On the similar grounds, the probability of making losses decreases as investment holding period increases and vice versa. In other words, the probability of losses and holding period have inverse relationship. The graph below highlights the probability of making losses is about 30% for one year holding period and almost 0% for 15 years holding period respectively.
Why invest for the long term?
There is a famous saying that “time in the market is better than timing the market” because it makes sure the money works for you instead of you working for the money. Inflation is the hard reality, and we cannot avoid it. Inflation eats up your savings over time by reducing your purchasing power. Therefore, investing is the only way to maintain or even grow your purchasing power. Timing the market can be very dangerous and is not practical for the long-term.
As demonstrated below, missing best performance days can amount to huge differences in returns. Being invested in the market for the long-term guarantees the best performance.
Investing for the long-term can be done in two ways:
• First, investing a lump sum in one go and then allowing the investment to grow for the long-term can be a good strategy if you have a huge amount to invest and want to avoid transacting investments again and again.ompare the costs between your current provider(s) and the pension offered by Simply Ethical.
• Second, investing a set amount with a regular interval (monthly, quarterly, yearly, etc.), which is best known as dollar cost averaging, ensures that you buy more when asset prices are low and buy less when asset prices are high.
Buy and hold strategy is acknowledged to be the best strategy to reap the benefits of long-term investing, however, there is no rule of thumb to define long-term in terms of holding period. It all depends on the investors’ risk and return objectives and individual circumstances or constraints. An investor can invest and determine his/her investment horizon based on one or more of the following objectives:
• Accumulating wealth to buy his first home or a second property.
• Saving for higher education for his/her children.
• Saving enough money to get working life flexibility or to become financially independent.
• Building wealth for his/her retirement life (private pensions).
• Any other life goals.
The above-mentioned life objectives require different investing time horizon to fit in the long-term investing definition, it could be as low as three years or as high as twenty or thirty years. However, one thing that is common in any investing time horizon is the buy and hold strategy to ride-off the market volatilities and to avoid the rhymes of market timing. The legendary investor Warren Buffett says our investment time horizon is ‘forever’. In the same context, he further says if you cannot hold a stock for ten years, do not think to invest in it even for one day.
Benefits of long-term investing
In addition to the above-mentioned benefits of long-term investing, there are some further benefits are as follows:
• Compounding effect of wealth creation is a powerful tool to accumulate wealth in the long run. Alongside your invested capital, any gains/returns on that capital will start earning if you reinvest those returns over the long-term and your portfolio grows exponentially over the years.
• Control on your emotions: long-term investing provides peace of mind and avoid haste investment decision-making during times of market turmoil. Psychology plays a big role to build investors’ sentiment and having control on your irrational emotions can set you apart from the crowd to be on the advantage side.
• Risk-reduction: investing for the long-term helps avoid ‘Mr. market’s’ fluctuations and makes your investment portfolio smoother.
• Efficient and low cost: long-term investing makes you more efficient as you can save a lot of time by not making frequent trades, which ultimately makes your portfolio cost-effective by avoiding trading fees, costs, and taxes.
• Investing flexibility: long-term investing provides you much needed flexibility when making investment decisions by investing through a disciplined approach best known as dollar cost averaging.
• Correcting your investment mistakes: no one can make perfect investment decisions, in fact never has been done in the whole history of investing. Every investor makes some investing mistakes. Long-term investing is a great way to correct your investing mistakes by sticking to the quality investments for the long run and adding more to those companies whose business model is robust, but asset prices are temporarily down due to the market turmoil. In this way, you can compensate those poor mistakes you made during your investing decisions.
And finally ….. have an open discussion with your Financial Adviser
Keeping calm and controlling your emotions during increased market volatility is difficult but it is the right thing to do. However, if you feel nerves and need assistance, talking to your Financial Adviser is always fruitful.
To learn more about how we can help you, book a free initial consultation with our Financial Adviser.
Past performance is not a reliable indicator of current or future returns. This overview contains general information only and does not consider individual objectives, taxation position or financial needs. Nor does this constitute a recommendation of the suitability of any investment strategy for a particular investor. It is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any trading strategy to any person in any jurisdiction in which such an offer or solicitation is not authorised or to any person to whom it would be unlawful to market such an offer or solicitation