THE BENEFITS OF TAKING A LONG-TERM APPROACH TO INVESTING

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“In the short run, the market is a voting machine but in the long run it is a weighing machine” is one of the pithy quotes attributed to legendary investor Benjamin Graham and it neatly highlights one of the great benefits of investing for the long term.

Setting a realistic timescale for investing is one of the crucial decisions to make when considering whether to save or invest. Getting the timescale right is about more than ensuring that any financial plans are not upended by market fluctuations in the short- to medium-term. We believe that investing for the long-term has many advantages for investors. These reasons include:

  • Investing on a timescale that matches investors’ aims - saving for retirement can last up to 50 years.
  • Allowing time for compound returns to boost the value of retirement investments and helping to stay ahead of the rising cost of living.
  • Avoiding trying to time the market so minimising the risk of buying and selling at the wrong point of a market cycle.
  • Keeping costs low.

Total return versus price return

The most common way of measuring the performance of equities is to compare them to an index, such as the FTSE 100 or S&P 500. These indices represent how the cumulative price of a group of underlying stocks have risen and fallen over time – but they only give part of the story. Using share price alone to calculate returns excludes any dividends or interest payments that would come from investing directly in the stocks – the change in share price plus any dividends or interest is called total return.

A look at the price return versus total return value of the FTSE 100 over the last 20 years provides an interesting example. On 30 December 1999, at the height of the dotcom bubble, the FTSE 100 hit 6,930. It didn’t get back to this value until February 2015 and by the end of September 2019 (almost 20 years later) the FTSE 100 was just 6.9% higher than its closing value at the end of 1999. However, this only shows how the price of the underlying stocks have performed. The FTSE 100 includes a large number of dividend-paying stocks; the average yield on the index at the end of August 2019 was 4.4%. That means investors in those underlying stocks would have also crucially benefitted from the additional dividend income over this period.

ALBERT EINSTEIN MAY NOT HAVE DESCRIBED COMPOUND RETURNS AS THE EIGHTH WONDER OF THE WORLD BUT IT IS HARD TO OVERSTATE THE BENEFIT OF CONSISTENTLY REINVESTING ANY INCOME GENERATED

Albert Einstein may not have described compound returns as the eighth wonder of the world but it is hard to overstate the benefit of consistently reinvesting any income generated. Of course, the longer you are able to keep up this recycling of income, the more powerful the compound return.

Investing over a long period of time also helps counter the effect of price inflation.

Putting savings in cash eliminates market risk but over the longer term means that inflation becomes an issue and can result in the value of savings being eroded over time. In contrast, potentially higher returns from equities could help offset the rising cost of living.

According to the Bank of England’s figures, the Consumer Price Index, the government’s preferred measure of inflation, averaged 2.7% a year between 2008 and 2018. The average return from the FTSE 100 over this period was 8.3%, based on total annual returns. As this is an average figure, it includes three years within this period when returns were negative and another year when the return was less than inflation, but taking a longer term approach significantly increases the chances of preventing inflation from eating away at the value of savings.

Avoid trying to time the market

“Time in the market not timing the market”, is another well-worn saying used to extoll the virtues of taking a long-term approach to investing. Very few investors can reliably and consistently select the best time to buy or sell investments and it is all too easy to become distracted by short-term noise and delay a decision to buy or sell.

In addition, while selling out of a falling market can help protect against some short-term losses, unless you time re-entry to the market perfectly you will also miss out on some of the gains when the market rebounds.

Instead of trying to move in and out of a rising or falling investment market, investors are often much better advised to adopt an investment time horizon and level of investment risk they are comfortable with and riding out any short-term market volatility.

As an additional factor, the speed at which financial markets can rebound when they hit the bottom means that investors on the side lines are at risk of missing out on some of the biggest gains.

Recent research from JP Morgan shows the long-term effect that missing out on these periods of sharp recovery can have on an investment.

An initial £10,000 investment in January 1999 which remained invested until 31st December 2018 would have seen an annualised return of more than 5% and would be worth more than £25,000. By missing out on the 10 best days of investment returns over this period, the annualised return would be just 1.7% and the total investment would be worth less than £15,000.[1]

Volatility is a fact of life for financial markets. The dotcom bubble and the global financial crisis are two of the more extreme corrections of the last 20 years but these have been interspersed with several other corrections. Taking a long-term approach not only allows investors to ride out the market fluctuations, it can also help boost investment returns.

Many pension investors make regular contributions over the long term and this can have several benefits. Adopting a disciplined approach to investing regular, smaller amounts helps to avoid the problem of trying to decide the best time to invest a lump sum.

Pound cost averaging can also help long-term investors; as well as helping to avoid the pitfalls of trying to time investment decision making, it can help to boost investment returns over the long term by allowing investors to purchase assets at a lower price during a correction and then seeing the benefit when they rise in value.

 

Keeping transactions costs low – and subsequently fund charges

The impact of charges and the effect they can have on investment returns is not a new revelation. It is no secret that actively traded portfolios can rack up considerable extra cost for investors and over time this adds up.

However, it can be useful to look again at the size of the additional costs that can be incurred over a long period of time.

In 2013, a study carried out by the Department for Work and Pensions (DWP) into the level of charges in workplace pensions highlighted the impact that higher charges can have.

The DWP’s figures show that over a working life of 46 years, a pension investor contributing an initial £100 a month (rising by 4% a year), and experiencing annualised investment growth of 7% a year would pay 13% of the total value of their fund if they paid an annual management charge (AMC) of 0.5%. This rises to 24% of the fund if the AMC is 1% and 34% for an AMC of 1.5%.

In cash terms, the difference between paying a charge of 0.5% instead of 1% over this period is almost £78,000.[1]

By taking an approach which deliberately keeps turnover in our multi-asset portfolios to a minimum, Scottish Widows can keep investment charges down and ensure investors keep more of their investment gains.

 

Scottish Widows’ approach to multi-asset investing for the long term

As the examples show, there are a number of sound financial reasons for adopting a long-term approach to investing.

When it comes to multi-asset investing, we believe that asset allocation has the biggest effect on a portfolio’s long-term performance and this is central to the design and ongoing governance of the Scottish Widows range of multi-asset funds.

Each fund within our range has its long-term strategic asset allocation set in line with Scottish Widows’ outlook - typically taking a 5-to-10 year view or longer of the financial markets. The long-term strategic asset allocation is reviewed every one to two years.

While the strategic asset allocation reflects a long-term view, medium-term asset allocation involves making adjustments to the weights of individual asset classes within a fund based on the expected medium-term performance of those asset classes. We generally consider the medium term as indicatively 18 months to three years.

Taking a medium-term view on top of the strategic asset allocation allows us to adjust the asset allocation within our funds. Our aim is to add value by reflecting our current views of the relative value and attractiveness of asset classes.

Sources:
[1] JP Morgan – Principles for successful long-term investing 2019

[2] “Better workplace pensions: A consultation on charging”, Department for Work and Pensions, October 2013

 

Other articles in this edition

INVESTING IN TIMES OF VOLATILITY

Volatility refers to the rate of price moves over time either upwards or downwards – it presents both potential investment risks and opportunities.

“VALUE FOR MONEY” IN PENSION FUND CHARGES

The change in focus from regulators is an acknowledgement that assessing quality in a pension scheme is about more than just cost.

FOCUS ON A FUND MANAGER: Q&A WITH NEWTON’S TIM WILSON AND BHAVIN SHAH

Launched twenty years ago, the Newton Managed Fund is one of the longest-running and largest funds in the Scottish Widows range.

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