Principles for Successful Long-term Investing

Market insights was founded in 2004 in the wake of the fallout from the tech bubble. At a time when investors needed it most, the first Guide to the Markets provided clarity and perspective, and helped to reinforce key habits of successful long-term investors. Today, more than a decade later, it is in that same spirit that we are pleased to offer, “principles for successful long-term investing”.

We believe that a combination of these principles, sound financial advice and deeper insights can help make every investor better off.

1 . PLAN ON LIVING A LONG TIME

We are living longer

Thanks to advances in medicine and healthier lifestyles, people are having longer lives. This chart shows the probability of reaching the ages of 80 or 90 for some who are aged 65 today. A 65 year-old couple may be surprised to learn that there is a 54% chance that at least one of them will live another 25 years, reaching the age of 90! 

Many of us have not saved enough

Many studies, including the one referenced here, reveal that individuals do not feel financially prepared for retirement. There is a significant shortfall between the number of years a person expects their savings to last and the number of years they plan to spend in retirement.

Investors should start early by saving more, investing with discipline and have a plan for their future. 

2 . CASH ISN’T ALWAYS KING

LEFT:  Cash is a real drag

Investors often think of cash as a safe haven, or even a source of income from earning interest. Holding more cash for short periods of time to protect capital in a volatile markets may be a viable strategy. However, holding too much cash for too long will create a drag on portfolio returns. Especially when cash rates are below the rate of inflation.

Doesn’t pay much

The interest earned on holding cash has been in decline ever since the global financial crisis (GFC). Central banks to poised to start rising interest rates again, but from very low levels and unlikely to match pre-GFC levels.

3 . AVOID EMOTIONAL BIASES BY STICKING TO A PLAN

TOP: Home-country bias

The Australian economy represents only a fraction of the global economy and accounts for less than 2% of the global equity market. Yet for most Australian investors, a large portion of their portfolio can be concentrated in this small portion of global capital markets.

BOTTOM: Familiarity bias and concentrated positions

The major Australian equity index, the ASX 200 Index, is not representative of global equity markets and has an out-sized weighting towards the financial and materials sectors, which includes banks and resource companies. Because of “home bias” and investors' preference for the domestic equity market, investors may find themselves having larger position in these sectors than a global investor.

It is important that investors are aware of these biases and employ a disciplined investment plan that can help minimise their influence.

4 . COMPOUNDING WORKS MIRACLES

LEFT: Start early and invest regularly

Compounding interest has been called the eighth wonder of the world. Its power is great that even missing out on a few years of saving and growth can make an enormous difference to your eventual returns. Starting to save at the age of 25 and investing AUD5,000 annually in an investment that grows at 5% each year would leave you with over AUD250,000 more by the age of 65 than if you had started at 35.

RIGHT: Re-invest income from investments if you don’t need it

You can make better use of the magic of compounding if you reinvest the income from your investments to boost your portfolio value further. The difference between reinvesting—and not reinvesting—the income over the long term can be enormous. 

5. VOLATILITY IS NORMAL; DON'T LET IT DERAIL YOU

Seeing through the noise

Every year has its rough patches. The red dots on this chart represent the maximum intra-year decline in each calendar year for the ASX 200 Index going back to 1994. While it is impossible to predict those pull backs, investors should learn to expect them; after all markets suffered double-digit pull backs in 21 of the last 28 years.

But investors should also have a plan for when the going gets tough, instead of reacting emotionally. The grey bars represent the calendar year market returns. They show that despite the pull backs every year, the equity market has recovered to deliver positive returns in most calendar years.

The lesson is, don’t panic: More often than not a pull back in the equity market is an opportunity, not a reason to sell.

6. STAYING INVESTED MATTERS

Don’t put your emotions in charge of your investments

Market timing can be a dangerous habit. Pull backs are hard to predict and strong returns often follow the worst returns. But often, investors think that they can outsmart the market or let the emotions of fear and greed push them into investment decisions they regret.

More importantly investors should position for the longer-term. Bull markets in equities can hand have lasted a lot longer than bear markets. In a case of long summers, short winters, investors should remember their long term objectives when positioning in markets. 

6 – STAYING INVESTED MATTERS (Part 2)

Good things come to those who wait

While markets can always have a bad day, week, month and even year, history suggests investors are less likely to suffer loss over longer periods.

This chart illustrates this concept. While one-year equity returns have varied widely since 1950 (+47% to -39%), a blend of equities and bonds has not suffered a negative return over any ten-year rolling period within the past 71 years. 

7. DIVERSIFICATION WORKS 

Diversification has served its purpose

The last 15 years have been a volatile and tumultuous ride for investors, with multiple natural disasters, numerous geopolitical conflicts and major market downturns. While volatility might be a normal part of investing, investors can help minimise some of these risks through diversification.

Despite the difficulties, one of the worst performing asset class of those shown was cash. Meanwhile, a well-diversified portfolio including equities, bonds and some uncorrelated assets returned 5.7% per year over the last 15 years. 

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