It’s been a tough year in stock markets: geopolitical turmoil, high inflation, rapidly rising interest rates, and concerns that the knock-on effect will almost certainly send some economies into nasty recessions has caused markets to fall and anxieties to rise.
During these times, investors tend to throw the baby out with the bathwater: selling anything deemed remotely risky. And yet, it’s all too easily forgotten that stock market falls are part and parcel of normal market cycles, and that sitting tight during moments of anxiety is often the best strategy. Here, we look at why giving our investments the time to flourish is one of the most important concepts in investing.
Picking the right horse for the course
Setting a sufficient time horizon is the cornerstone of any successful investing strategy. Different assets come with different risks – the variation in returns we potentially receive – which means we must invest in the appropriate asset classes for the time horizons of our financial goals and the risks we are willing to take.
Cash is viewed as fairly risk free, so may be appropriate for nearer-term goals. Turning the dial up a bit, there are bonds, such as government and corporate bonds. Here, we see the risks increasing and therefore potential rewards or loses, so a longer horizon is likely needed if we are to invest.
Then we get into stock market investing – buying into the shares of companies. As broadly the riskier of the asset classes, price swings can at times be fairly wide. It’s why there’s the potential for greater gains, but also greater loses, therefore setting a much longer investing time horizon is wise if we hope to avoid being in the red with our investments when it comes to selling them.
Understanding that it can be a bumpy ride helps us to appreciate why during these times we need to hold on tight with our investments.
The ups and downs along the way
Stock market values are a reflection of information, meaning that as news emerges that changes the operating environment for companies – be it regarding the economy, geopolitics, or at times, the businesses themselves or the sector they’re in – markets will shift as they absorb the impact of that information and reflect it in the value of shares.
As certain times, the news can be particularly grim, and falls may be hefty. History tells us that not only is this very normal, but economies and stock markets tend to recover, and that the ups and downs will almost certainly happen again and again as economies journey through their natural cycles.
As a result, stock markets go through long periods where they rise, known as bull markets if gains are more than 20%, and shorter periods where they fall, known as bear markets if falls are more than 20%.
From 1946 to the beginning of this year, the UK market, as measured by the FTSE-All Share, has seen 11 bull markets and 10 bear markets, with the bull years accounting for nearly 65 of those 76 years, and bear markets just 11.
While some of the bear markets have been nasty, the bull markets that have followed have been longer and stronger. Black Monday’s crash in 1987 led to a 34% decline over the ensuing months, and yet, the bull market that followed lasted nearly 13 years and delivered an eye-watering gain of 571% from trough to peak1.
What is more, a big chunk of the gains tends to come soon in the recovery periods that follow, sometimes in the days that follow. It’s why it’s so important to remain invested and keep your investment time horizon sharply in view.
Warren Buffet is the world’s most successful investor, and in a letter to his investment company’s shareholders in 1996, he famously remarked: “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”
£3 billion global equity investment trust Alliance Trust have looked at data to quantify the differences between remaining invested versus selling down investments during moment of market panic.
They compare two investors: the Patient Investor and the Impatient Investor. Each are given £10k in 1992 to invest in Alliance Trust, to which they add £100 each month and reinvest all of the dividends paid out by the Trust.
Whenever the market drops 5%, the Impatient Investor sells 25% of their holdings, and when it rises by 10%, they buy them back again. The Patient Investor sits tight.
30 years later, the Impatient Investor has a portfolio worth £238,000, whereas the Patient Investor has a portfolio worth £421,000 – a difference of £183k!
Markets are undeniably volatile, but it’s at times like these we must be patient. So, hang on – it may be a bumpy ride. But it’s worth it in the long run.