Long term investing - the importance of staying invested during difficult markets
Monday 28th February, 2022
As we find ourselves going through a period of global economic and political uncertainty, it is quite reasonable to ask whether you should be selling out into cash, or whether it is best to remain invested. In order to address this question, I have put together the article below. It will look at historical data in order to explain and justify the importance of remaining invested over the long term, despite the apparently dire economic circumstances.
I hope you find this article useful, but if you have any questions you would like to discuss, then please don't hesitate to give Atticus Financial Planning a call.
We have all heard the old mantra about buying quality and holding for the long term. If you have ever taken financial advice, your adviser will most likely have told you that the money should be invested for at least 5 years. Whenever I tell client’s this, they always agree with me. They understand that markets go up and down, and that holding your investments for a longer time allows your portfolio to make up for any falls that it may suffer early on, as well as any initial set up costs.
However, when we get to real market turbulence, like we have just experienced, I am often contacted by friends and clients and asked whether they should be getting out of the market. Should they be getting out of stocks and into gold, because that is always a safe bet in difficult global economic conditions.
These are all really reasonable questions. It is scary when you have invested and the value of your money is going down. It is a helpless feeling, because no amount of wishing is going to change the direction of the market. When it feels like the value of your investments is burrowing down like a homesick mole, it is incredibly difficult not to throw in the towel and sell out. Afterall, seeing the reduced portfolio values can hurt and pain is our body’s way of saying, “Stop doing what you are doing!!”
To compound all the stress, the media is suddenly flooded with all sorts of hyped-up headlines about billions of pounds being wiped off stock values and this being the end of equities. I have been working as a financial adviser since 2004 and I can honestly say that there has seldom been a moment where the end of equities as a viable investment option hasn’t been predicted. There has seldom been a month where I haven’t seen a headline questioning whether it is worthwhile to hold fixed interest as an asset class.
I was working in London when the 2008 crash took place and I watched the poor staff leaving the Lehman offices clutching boxes of their personal effects to their chests. I was still pretty wet behind the ears at that time and on my morning commute I read the terrible headlines about the dire economic situation. I remember going to my boss and friend, Ian Dyall, clutching the doomsaying newspapers in my hands. Ian, who is one of the most understated finance geniuses I have ever met, simply shrugged and said tiredly, “Ignore that, they don’t know what they are talking about. They’ll be singing a different tune tomorrow.”
He was right. Where the papers all predicted the end of the world on the Monday, by Tuesday they were all talking about it being the greatest investment opportunity ever. This roller coaster of conflicting headlines continued every single day. Once the bull market had finally taken hold, the headlines shifted from speculating about how the economic world had changed in ways we could never fully understand, to predicting when the bull market would end. Over the period of almost a decade, I read regular headlines about the markets being overvalued. And yet, they kept going up. There is a lost decade of investors, who spent their time waiting for the predicted crash to happen, so that they could get in at the bottom of the market. When a true market crash actually happened, it once again came from a completely unexpected quarter and in the form of global pandemic.
I mention all of this to highlight the fact that there are thousands of incredible economists and financial analysts in the world. These are often some of he most wonderfully intelligent and intuitive people. And despite this, they are unable to predict with any real certainty what the markets will do over a short-term period.
This brings us right back to the key focus of this article, which is: why do we encourage you to invest for the long term? In this article I will look to find support for this approach and I will also try and convince any wavering investors to stop, pull their finger away from the sell button, and wait out any market fluctuations, regardless of how scary they are.
The long-term performance of the markets
I will start this journey by firstly looking at the long-term performance of the market.
Now there are thousands of different markets out there, so this is quite a difficult thing to do. I have therefore decided to look at the performance of the MSCI World Index as an example.
The MSCI World Index is an index made up of approximately 1,546 companies from 23 countries around the world. It excludes stocks from emerging and frontier economies, and so isn’t a truly “world” index, but I feel is sufficiently broad in its scope for the purposes of what we are trying to illustrate.
I have taken data provided by Curvo to replicate the performance of the index from 1978 to 2021.
The main purpose of this graph is to demonstrate that the long-term trend of the growth is up. There are a few corrections and crashes along the way, but the long-term trend is a generally slow and unstoppable upward curve.
I have also added in details of the various economic crises the world has faced during the period covered. I have not added all of them, because in reality there is some form of growth impacting crisis happening every single year. I have therefore only included the crises that seemed most salient and impactful from the smorgasbord of options I had to choose from.
The reason I have added these, is to highlight that, bad things do happen in the world, and some of them can have quite a big impact on the value of markets. Let’s look at a few of these market events.
Black Monday took place on Oct. 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. This was a huge market shock. Peter Lynch, one of the world’s greatest fund managers, writes about being stuck on a golf course in Ireland, as the value of the markets plunged. By the end of the month, most of the major exchanges had dropped more than 20%.
Over the short term, it would have felt horrific, but in the context of the long-term graph above, it is a small speed bump in the gradual rise of the market.
The 2000 Dot-Com Bubble
This was a period of excessive growth in tech markets caused by heavy speculation in internet-based companies in the late 1990s. It was a time of massive exuberance, as companies looked to take advantage of the opportunities offered by the internet. This all came to a screeching halt, when the NASDAQ Composite Index fell 78% in value from 2000 to 2002.
It is important not to breeze over this one. If you had invested at the top of the Dot-Com Bubble, you would have had to wait until 2013 to start breaking even. The decade from 2000 to 2010 was a bit of a pig when it comes to investment returns in certain sectors and asset classes. It was book-ended between the Dot-Com Bubble and the 2008 financial crisis promptly followed by the 2010 Sovereign Debt Crisis. It was also peppered with the tragedy of the 911 Attack and the 2002 market downturn.
This type of situation probably gives investors nightmares, but it is important to look at the facts more closely. If you had been invested in a more diversified portfolio, this poor performance would have been less pronounced.
According to Morningstar (Neptune: Emerging Markets Will Never Repeat 2000's... | Morningstar), between 2000 and 2010 the BRIC nations returned 370%. Emerging markets were exploding. This would have mitigated some of the poor performance of the more established markets in the MSCI World Index.
Forbes highlighted in their article It's Not Really A Lost Decade (forbes.com) that the poor performance in US stock over the period 2000 – 2010 was limited to large cap stock and that small caps had still generated a reasonable return.
In addition to this, a well-diversified portfolio would also contain corporate bonds, government gilts and commercial property, which would have further reduced some of the poor performance of the more established companies and economies.
As highlighted in the Forbes article, a key to avoiding the long term doldrum experienced in more developed large cap equity markets from 2000 – 2010, is to diversify across regions, industries and asset classes.
The 2008 Financial Crisis
This was the first really substantial recession of my career and I will be honest and say that at times it felt like the world was going to end.
It was caused by a perfect storm of circumstances including:
- Lending substantial amounts of money to people who could not afford it
- Negligence and poor risk management by global financial institutions
- The stalling and eventual crash of the US and other property markets
- The creation and sale of complex mortgage-backed securities and other derivative backed investments that were unable to withstand the stresses of a market reversal
The reality is that no one saw this coming. It was actually preceded by a period of exuberance in world economies. Consumers were buying and financial institutions were providing them with the credit to do so. When the crash came, it took everybody off guard and it was brutal.
However, when you look at it from the perspective of the graph above, it was mercifully short and from 2009 continued into the longest bull market in living memory.
The Covid Crisis 2020
This crisis is still fresh in the memory and once again it has been caused by something none of us could have foreseen. In this situation, many countries in the world voluntarily stalled their economic growth by locking their populations down and restricting a large amount of commercial activity.
Despite the complexity of the crisis and the high levels of uncertainty created by the proliferation of different COVID variants, the initial sharp drop in the market was actually short lived. Many investors saw their portfolios fall and then rise back up just as quickly and often actually ended the year in profit.
So, what is the point of discussing all these crises, their causes and their impact to the graph above? Well firstly, I am highlighting that there will always be different crises and no one can foresee them. Anyone purporting to predict the next market crash is probably trying to sell you something. Markets are a bit like the worst flat mate you can imagine. They are emotional, irrational, messy and don’t care about the world around them. And just when you think you have figured them out, they pull some other piece of unexpected craziness out of the hat.
To demonstrate some of this instability in markets over the short term, take a look at this graph of the MSCI All Country World Index for quarter 1 of 2018:
The volatility displayed over this relatively short time frame illustrates just how hard it is to make short term predictions about the performance of any market. The market itself is skittish and the investors are focussed on self-preservation and a desire to take advantage of any opportunity. Therefore, the market falls at bad news and rises at good news, and there is no shortage of both positive and negative news.
Many active fund managers try to take advantage of these fluctuations in order to generate extra returns for their investors. They try to pick individual stocks/funds or other investable assets that will allow them to beat their market in a given situation. When I look at a short-term graph, like the one above, I cannot see how they do it.
However, when we look at the graph of the MSCI World Index over the long term, it is possible to see that there is a long-term trend and that the trend is upwards. It is therefore possible to look at a market and make a reasonable long-term prediction, which cuts out the noise of the short term. For example, there are very few investors out there who do not believe that the Chinese economy will continue to grow in size over the medium to long term. Furthermore, there are very few investors who honestly feel that the tech market has reached its zenith and has no further growth to offer over the medium to longer term. The long-term asset allocation for a portfolio is called its strategic asset allocation. Therefore, responding to short term changes in a particular region or industry seems to make little sense when the overall trend seems to be up. All these short-term responses can do is increase cost, complexity and uncertainty.
Now, it is important to note that there is a difference between periodically adapting the long-term asset allocation, to reflect new information and how it impacts the long-term view, and manically adapting your holdings in a desperate attempt to make profit out of every market fluctuation. The former is known as tactical asset allocation, and has proved very valuable, as the focus is on utilising historical data and evidence to determine how current circumstances will play out over the long term, and how to adapt the long-term asset allocation to reflect this and make it as efficient as possible. The latter strategy is more focussed on speculating how certain stocks or assets will react to certain short term market stimuli to try and generate additional returns and beat the market.
Pick your strategy and stick to it
This is really important. When your financial adviser says to you that you need to be invested for at least 5 years, then long term investment is your strategy. Chopping and changing your investments regularly in order to take advantage of short-term market changes is contrary to your strategy. Attempting to sell investments at the peak of the market to avoid losses and buy at the bottom, is virtually impossible.
I have had conversations with numerous friends and clients who have told me that markets are overpriced and at the top of a cycle. Now, that may be true, but what if it is not the top of the cycle? What if 8500 is destined to be the new ceiling? Are you willing to risk being out of the market, based on your hunch that this is as high as it goes? For ages 6000 was the ceiling. Then, between 2010 and 2021, it became the floor.
There is a great piece of research done by Fidelity, that shows that if you missed the best 10 days in the market from 01/01/1980 to 31/03/2020, the returns on $10,000 invested over that period would have fallen from $697,421 to $313,377. That’s a big price to pay for a hunch.
In order to demonstrate the importance of sticking to your strategy, I will use an example from the world of short-term trading: The Turtle Trading Strategy.
Turtle trading is a legendary story, and it arose out of an argument between two traders, Richard Dennis and William Eckhardt. Richard believed that traders are born, not taught. Dennis disagreed. He believed that he could take any group of people off the street, teach them a set of trading principles and a strategy to stick to, and provided they stuck to the strategy, they would be successful. You may recognise this plot, as it was turned into the movie Trading Places, with Eddie Murphy and Dan Ackroyd.
It is a long story, but at the end of the day, Eckhardt won the bet, as the people he took off the street and trained, earned more than $175 million in only five years (Investopedia – Turtle Trading – A market legend). The amazing thing is this; the strategy he taught them relied on the fact that 60% of their trades would lose money. Therefore, to be successful the newly trained traders had to accept that the system they had would be profitable, even though the majority of their trades would result in losses. The principle behind this short-term strategy was to cut your losers short and let your winners run. The psychological pressure not to sell winners and take profits or hold onto losers in the hope that they would turn around, must have been immense.
The reason I mention this, is because the principle is the same in long term investment. History and probability say that the most likely outcome of putting together a well-balanced, well-diversified portfolio of funds, is that it will make a profit over time. The level of profit isn’t guaranteed and there are many factors that will affect that.
To support this assertion, I quote Pacome Breton in his article for Nutmeg (The facts about long term investing – Nutmeg – 01/12/2021)
“Looking at global stock market data between January 1971 and December 20211, if you had randomly picked one day during this period and chosen to invest just for that one day, you would have had a 52.5% chance of making gains — almost a similar odd to the toss of a coin.
Long-term investing dramatically increases your chances of returns. Just weeks more in the market can make a considerable difference.
If you had invested your money for a quarter, or 65 days, during that same 49-year period, your chances of making a profit increased to 66.1%. Investing for any one year would have generated a positive return 72.7% of the time, while investing for ten years increased your chances to 94.15%.”
Therefore, based on this information, it is clear that the longer you hold an investment, the greater your chance of making a profit.
The aim of the article above is to highlight the importance of investing over the long term, instead of trying to guess what the market is going to do. The reality is that the markets are fundamentally unstable. They are ruled by two very irrational emotions, fear and greed.
However, we can make rational decisions about the underlying fundamentals of a market and its general long-term direction.
With investing, we need to accept that we cannot control the market. It has a mind of its own. Therefore, we need to focus on controlling those factors that are controllable. These include:
- Controlling our asset allocation
- Controlling investment costs
- Controlling the tax efficiency of the returns we achieve
- Controlling when we exit our investments and our investment time frame
By controlling these factors and sticking to our long-term strategy, we maximise our chances of generating positive returns.
If this is something you would like to discuss, please don’t hesitate to give Atticus Financial Planning a call. We are always happy to help.