Taking the long-term view: the investment marathon
People often say ‘Life is a marathon not a sprint’, and the same is true when it comes to investing. Time in the market is often one of the key routes to success. We take a look at why investing could be viewed as an endurance race rather than a dash for the prize, or how the tortoise usually beats the hare.
Peaks and troughs
While markets have historically moved upwards over time, their progress is never purely linear.. For example, the Hang Seng Index first passed the 10,000 mark in December 1993. It hit the 20,000 milestone 13 years later in 2006. Today, it trades around the 29,000 mark in December 2017. But during this period it has risen as high as 31,958 in October 2007, and fallen as low as 9,426 in March 2008 during the Global Financial Crisis. The Hang Seng also dropped sharply in response to the Asian Financial Crisis in 1997.
More recent events have had a negative impact on the market too, with the Hang Seng dipping in response to triggers as diverse as the devaluation of the Chinese Yuan in 2015, the election of Donald Trump as the US President and the UK’s decision to leave the European Union, which saw the index plunge 1,000 points in one day.
In short, it can very difficult to get the timing of a market right, and depending on your circumstances it could be better for you to be patient, taking a long-term view.
Compound returns are your friend
It is claimed Albert Einstein once said: “Compound interest is the most powerful force in the universe.”
The principle of compound interest or compound returns refers to the practice of receiving growth on growth. To put it more simply, if you invest HK$1,000 in shares and receive a 5% return in the first year, the following year any gains you make will be on HK$1,050, meaning the same 5% return will net you HK$52.20, rather than the HK$50 you made in the first year.
While over a single year that may not sound like a big deal, it is very powerful over longer period of time. For example, the same HK$1,000 investment would be worth HK$1,648 after 10 years and HK$2,718 after 20 years, assuming an annual return of 5%, showing the benefits of sitting tight and waiting.
Compound returns can be particularly powerful when it comes to equity investments because as well as benefiting from growth in the value of the shares, you also receive dividend income.
For example, between 2004 and 2014, the UK’s FTSE 100 Index rose from 4385 to 6598, a gain of around 50%. But once the impact of dividend payments is factored in, an investor tracking the index would have made of 115% during the 10-year period if they had reinvested these dividends.
Frequent trading erodes gains
While it may be tempting to chop and change your portfolio to get into the latest fad investment that is performing well, this behaviour can actually be extremely damaging to your returns.
You will typically be charged fees and tax every time you buy and sell shares. Even if these charges are low they still eat into your gains.
The most famous statistical study on this issue was carried out by two members of the Graduate School of Management at the University of California between 1991 and 1996. They analysed the returns of more than 66,000 households with accounts at a large discount broker and found those that traded more frequently earned an annual return of 11.4% over the period, significantly lower than the average account, which made 16.4%. Their conclusion was: trading can be hazardous to your wealth.
Stay focused on your goal
Equity investments generally suit medium to long-term goals, such as saving for retirement or a child’s education. While these goals are still some way in the future, you have time to ride out the troughs in the market. When stock markets fall it can be tempting to panic sell, but if you do so, you will simply ‘lock in’ your losses.
Instead of trying to time the market, stay focused on your goal and to create a well-diversified portfolio designed to provide you with the appropriate levels of risk and return under a variety of different market scenarios.
Of course, no-one can predict or control the returns a market will provide, but having the right strategy in place could help your portfolio go the distance. If you are not sure how to do this on your own, it is a good idea to seek advice from a qualified financial advisor.