Why it pays to take a long term view when you’re investing

Pound coins stacking up as someone thinks about investing

Investing

Gareth Trainor

16th January 2015 at 11:32am

It’s normal for financial markets to go up and down over time, but in the short term these movements can be unnerving. Even working in finance as I do, when I see my investments fall in value it can ‘feel’ as though I’m losing money I’ve worked hard to save.

It is true that whenever you invest you need to accept that you could get back less than you paid in, but these worries can mean it’s easy to take a short-term view and effectively cheat yourself out of a better performance. If you can keep your composure and take a long-term view, you’re much more likely to do well financially. And that can help you meet your financial goals.

Focus on the long term, not the short

Why is it so important to take a step back and keep the long term in mind? Does it really make that much difference? To get some idea, let’s look at how the FTSE® All-Share index has performed over the last 30 years.

Let’s assume you held your investment for a short, three-month period over those 30 years. You’d have got a positive return 69 per cent of the time*. That’s not bad – but it’s probably not the kind of reassurance you need if you’re venturing your life savings on it.

But if you’d taken a long-term view and held on for ten years rather than three months, you’d have got a positive return 98.7 per cent of the time – a far more comforting figure. And over 15 years, the numbers are even better as you’d have benefited from a positive result 100 per cent of the time. That means there’s no 15 year period in the last 30 years where the FTSE® All-Share would have lost you money.

*Source: FE August 2015. Calculations run from 31 December 1985 to 31 August 2015 and are based on the number of positive periods calculated on a rolling monthly basis at month end. Returns are based on income reinvested (net).

Crunch the numbers

The last ten years have, of course, included the credit crunch.

It might seem safe to assume that this will have had a huge impact on performance during that time. But in fact, over the last ten years, the overwhelming majority of investment funds have had a positive performance. Of the 1,400 or so funds with a long enough track record, an impressive 95 per cent gave a better return than cash over those ten years. And they’ve had an average yearly return of over 6 per cent during that time period which meant that, on average, they more than doubled in value over ten years.*

*Source: FE IMA universe, cumulative returns, gross income reinvested. 31 August 2005 to 31 August 2015.

Buying low and selling high is the ideal

It’s very easy to lose your cool when investing, and panic when you see the value of your investments, including your pension funds, fall and fall. When this happens, it’s quite likely you’ll be hugely tempted to sell your investments, and keep the money somewhere ‘safer’. But if you do, it means you’re likely to be selling after markets have already fallen – and crucially, before they rise again. That means you lock in your loss.

So although it’s tempting to take your money out when markets fall, it’s not normally a good idea. You run the risk of missing the rebound, and have less money than someone who kept their composure.

Alternatively you might see markets doing really well. You get excited, and want to buy in to them. But if you do that, you could end up buying at the top of the market and might just see your new investment fall soon after you buy it – euphoria quickly turns to anxiety

What about retirement income?

If you’re looking at staying invested through retirement and taking an income from your investments, the rule of ‘think long term’ is as important as ever. But there’s one vital difference – in retirement you need to watch carefully for volatility in the early years. I’ll be writing more about how too much volatility early on can significantly impact the long-term prospects for your pension in my next blog.

But that doesn’t change the fact that panicking over short-term market movements can have just as bad an effect on your retirement income in the long term as it can when you’re still saving. Just remember, when you’re investing in retirement you should choose investments that give you confidence to take the income you need from your investments throughout your retirement and that manage volatility in those critical early years.

Respond, don’t react

So, what should you do when you see your investments fall? Responding to these events is fine – it’s worth checking your investments to make sure that what you’re invested in is still appropriate for your goals and your circumstances. Just be sure you’re making any changes for the right reasons and don’t react out of panic. When markets are rocky take some deep breaths, try to keep your composure, and focus on the long term.

This blog and any responses to comments should not be regarded as financial advice. Law and tax rules may change in the future. The information here is based on our understanding in August 2015. Your personal circumstances also have an impact on tax treatment.

A Stocks and Shares ISA and a pension are investments. The value of investments can go up or down and may be worth less than you paid in. Past performance is not a reliable indicator of future performance.

 

Join the conversation

Join the conversation and follow us on twitter @StandardLifeUK and Facebook.