The Case for Long Term Investing
THE CASE FOR LONG TERM INVESTING
They say patience is a virtue, but it’s never easy to hold on to your investments and see it to maturity over the long term. Short term trends, market noise and behavioural biases in investing are often distractions that get in the way of our long term investment goals, so it is always important to keep the end view in sight.
Compared with short term trading, long term investing has usually proved to be a more successful approach in building up a nest egg or accumulating wealth. Here are some of the benefits it brings:
- The power of compound interest
The most obvious strong suit for long term investing is the power of compounding interest it wields. The general rule of thumb is that the earlier you begin investing and the longer your time horizon, the more portfolio growth you will achieve. Investors should also bear in mind that market noise and trends may be temporary. While it can be advisable in some instances to tweak or adjust your portfolios accordingly, it is not advisable to overreact to market movements. Staying for the long haul helps in compounding interest.
- Dividend income
Long-term investors will also benefit from dividend income. According to calculations done by Barclays Capital, dividends delivered half of an investor’s total real return (the return after factoring in inflation) from shares during the past 20 years. Unknowingly, small but consistent amounts of income can add up over a long period of time.
- Less prone to bad timing
Longer durations of investment in shares or share-based funds are less prone to the risks of bad timing, as a long term investor in the market for the long haul is likely to make fewer buy or sell calls compared with a short term speculator. Instances of bad timing would be buying just before prices fall, or selling before prices rise.
- Fewer expenses
Fewer buy and sell calls also means that long-term investing saves on investing expenses. Frequent or active trading involves transaction costs and brokerage commission fees, so speculators end up paying more for their transactions, thus reducing their true investment profits.
- Lower risk of human error
As humans, investors need to recognise themselves as creatures of emotion and irrationality. It is not uncommon for people to make an investment decision based on herd mentality or selective perceptions. Furthermore, short term traders tend to be reactive to market conditions. When investors choose to remain invested for the long term then, they avoid making such costly mistakes.
- A chance to right the wrongs
A longer investment horizon also gives investors the opportunities to fix investment mistakes. By starting to invest early on in life, investors would have the advantage of time to recover from any errors in judgment. A bad year in stocks or fund performances can always be neutralised with more positive years, so if a portfolio isn’t performing up to expectations, investors have the time and opportunity to tweak it into something that will address future financial goals.
- Wider investment options
Short term traders have to automatically exclude their pool of investment options to instruments that are illiquid, meaning investments that may have a lock-in period. Long-term investors have the option of parking their money in such illiquid investments as they have time on their side, and can also opt to stay long term in liquid investments.
However, long term investing doesn’t mean investors should just buy and hold their investments. It’s important for investors to take up a proactive role in their investments.
- Manage your investments
Get involved firstly by understanding what exactly you are invested in, monitoring earnings reports and keeping up to date with the latest related news. Look at your portfolio every quarter to ensure it’s still reflective of your asset allocation and financial goals, as market fluctuations can change them sometimes. When that happens, rebalance your portfolio to keep your investments aligned with your long term strategies.
- Dollar cost averaging
This means making regular contributions regardless of the market’s ups and downs. When the investment’s price declines, investors get more shares with their contribution, which lowers the average cost per share. The lower the cost to invest, the greater the potential rate of return.
- Have an exit strategy
Lastly, it’s crucial for investors to have an exit strategy, even with a long-term investment. Sometimes circumstances change and the investment may no longer be aligned with the investor’s financial goals. In such cases, it would be time to reevaluate and perhaps move on.