How variety could be the spice of long-term investing
Investors could rarely achieve their investment goals by focusing on just one asset. Find out why.
Generally, there are no hard and fast rules when it comes to investing. Some investors may study the most complex and deepest theories to gain insights into market trends, and seek potential opportunities for greater returns. Others could keep faith with a number of fundamental investing principles and strategies to help them achieve their investment goals.
Physicist Albert Einstein reportedly said, “compound interest is the eighth wonder of the world.” Probably, Einstein knew investors cannot beat time, and that compound interest has the potential to become an advantage.
Indeed, long-term investing could be relatively straightforward and one could work towards achieving better outcomes by optimising these three ‘dos’:
1. Do harness the power of time
It is important to start saving and investing early to optimise the benefits of compounding. For example, if an investor had invested US$100 in the MSCI World Index in 1970, the return on price alone would have grown to more than US$2,600 as of end-December 2020, with an annualised return of 6.7%1.
If the investor had reinvested the dividends, the long-term returns brought about by the compounding effect will be more significant. Regardless of whether dividends are reinvested1 in cash or stocks, they can provide more than the price returns. As of end-December 2020, the US$100 investment has currently grown to more than US$6,900 and over US$11,600, with annualised returns of 8.7% and 9.8%1, respectively. Therefore, start investing early and let time do the work.
MSCI World Index: Performance based on different scenarios1
2. Do invest regularly
Over the past two decades, the world has experienced geopolitical turmoil, recessions and a public health crisis that have led to various market ups and downs. Such market volatility could likely persist as the investment environment continues to evolve.
Still, some investors could become vulnerable to short-term volatility by surrendering to their heightened emotions and make ill-timed investment decisions. Others could try to capture the potential opportunity to ‘buy low’ and ‘sell high’ in volatile markets. Many random factors could affect the investment environment and it can be tough to accurately time a market entry or exit.
Moreover, the more frequently investors enter and exit the market and the longer they wait-and-see, the more out-of-market-risk may result. Even if the market is favourable, they could lose potential returns with this approach. And the potential compound losses from the failure to maintain sustained investment could be even greater. Instead of trying to time the market, we believe it's more important to keep investing.
3. Do diversify
No single asset class can be an all-time winner. Investing all funds on a single or a small number of assets, especially assets with relatively poor liquidity, could increase concentration risk. It is important to keep in mind that different assets have different characteristics. Taking equities and sovereign bonds as examples, the correlation between the two types of assets has been low previously, and even had a negative correlation2. Additionally, diversified investment in multiple assets with different characteristics could help increase return potential in the long-term while managing risks.
The correlation coefficient between stocks and sovereign bonds2
From 2010 to 2020, cash returns had been sluggish. Investing in developed market equities alone will deliver relatively high returns, but also relatively high volatility. For a diversified investment portfolio, an investor can achieve an annualised return of 6.4%, with annualised volatility at a moderate level of 9.1%, much lower than the 14.1%3 of developed market equities.
Could investors on their own create a diversified portfolio that may incur higher transaction costs and build the expertise to manage a range of asset classes? This could be complicated but they can instead optimise mutual funds and other investment tools.
Through active investing, fund managers could employ different investment strategies to add various types of assets across sectors, markets and regions in a portfolio, optimising the benefit of diversification.
Long-term investing could be a relatively simple and straightforward process when investors can optimise compound interest, diversify across asset classes of relatively lower correlation and keep investing continuously.
In a digital age, investors could also leverage online tools provided by fund management companies to regularly review their investment portfolios conveniently and seek professional advice based on their investment objectives and risk appetite.