Why investments need to focus on the long term
A friend was telling me about an old guy who lived across the road from him. Known only as Mr Storm, he was 104 years old when he died a few years ago. As a young man, Mr Storm had been a sugar broker in Indonesia, and came back to Australia after World War II with a decent amount saved. He managed his own portfolio, and as it grew substantially, he became a major supporter of many charities.
One day, the friend was chatting to Mr Storm on his front verandah, where he was soaking up the midday sun. As often happened, the conversation was interrupted by a phone call from the old man’s broker, and the friend heard BHP discussed. After the call, my friend said, “I saw BHP fell back 30 cents yesterday, it’s lost a lot recently, now $32.” Mr Storm cleared his throat and barely lifted his head, the sun bright on his pale skin. “Most of mine cost about $5,” he replied.
I tell this story because the perception of the share market’s performance, whether it’s a good place to invest, depends on your investment horizon. Or more specifically, your entry point, because performance is often determined by when you buy, especially for an investor rather than a trader. It’s amazing to recall that the Commonwealth Bank was floated in 1991 at $5.40, and 26 years later, not only is it now about $85, but it paid a fully franked dividend of $4.21 last year. Should anyone who bought it in the float really care if the share price falls 10% or 20%?
When you look at a long-term chart of the Australian stock market, say over 100 years, while there have been dips along the way, it looks like a never-ending rise. The personal investment horizon is the crucial factor. Some of those dips felt more like craters at the time. However, if it’s true, as the United Nations has claimed, that the first person to live to 150 is already alive, then that person could happily invest all their savings into shares, and it would probably be a good asset allocation over a multi-decade horizon.
However, since 1875 there have been 14 stock market cycles in Australia, where a cycle is defined as a fall in the price index for the broad share market of at least 20% from the previous top. Many people panic when the market falls 20 per cent or more, and they sell at the bottom and miss the subsequent recovery.
Of course, falls and recovery can be much worse than the average, and losing money just before or into retirement can be stressful, especially as the market can take a decade or more to recover. The variation between share market cycles is significant, which is one reason why comparing one time period with another is problematic.
For example, the average time it takes to recover the loss of a 20 per cent or more fall after a new bottom is about 44 months. So although the market usually recovers to the previous high on average in less than four years, the current market is still below its pre-GFC high in 2007, 10 years after the event.
In a world where investors should expect to be retired for 30 years or more, most would benefit from a greater tolerance of short-term volatility. This has crucial asset allocation implications. Many superannuation funds are designed now according to ‘lifecycle’ principles, with less allocated to shares over time to reduce the volatility as people age. A typical ‘lifecycle’ fund will reduce the share market allocation from 90 per cent at age 50 to 40 per cent by age 60. Investors and advisers need to decide if that is too much too soon, given the good long-term returns from shares and perhaps less from long-term bonds as we enter a period of rising interest rates.
Investors need the right risk tolerance and an investment horizon that suits them, as nobody wants to lose sleep at night worrying about volatility and their money running out. But most would benefit if they kept their eyes on a long-term outcome.
What experiences have you had with your investments? Let us know in the comments below.