What every member should know about long-term investing

“I think if they can simplify it, especially for the younger person, it all seems like gibberish sometimes. If they can find a way to simplify it and find a way to stress the importance of it. As a 19 or 20 year old, you don’t grasp the importance of it until you’re maybe a bit older.” Young member focus group, Sanlam Benchmark Survey 2015

As a client, you may have heard me say “the secret to investing is addressing the right risk at the right time” on more than one occasion. You may also have heard me say that the “right risk” to address for a young member is that of insufficient investment returns over the long term as this has the biggest impact on a member’s ability to retire in a dignified manner. The question is how to get the message across to our younger members whose energy and attention is focused elsewhere? Consider this angle.

Equity markets yield the best returns over the long term
To get the best returns over the long term, you have to invest in an aggressive portfolio such as a lifestage strategy. When you do this you, need to bear in mind that equity markets can be quite volatile and may give negative returns in the short term from time to time, as most keen investors will attest to. This is perfectly normal and is simply the nature of the markets. Despite this, the markets will still give you the best returns over the long term. You may think of the old saying that goes “if you can’t take the heat, stay out of the kitchen”. However, the nice part about long-term investing is that once you put your assets in the proverbial oven / the market, you are free to leave them alone and walk away. In fact the longer you leave them alone, the better. Here’s why.

Investing is a long-term game
The chart below shows the predictability of investment returns, based on a simple statistical model using recent market returns:

The blue line shows the middle of the road return for an investor with an investment horizon of 1 to 50 years. The grey dotted line shows a kind of “worst case” scenario – 9 out of 10 times, the outcome would be expected to be better than this. The red dotted line shows the “best case” scenario – only 1 out of 10 times could the investor expect to perhaps do better than this. What this graph tells us is that the longer the investment horizon, the smaller the spread between the worst case and best case scenarios. So the longer the term of your investment, the more likely you are to get a good positive return. The shorter the term, the greater the risk of loss.

Over one or two years the expected returns in the model varied between -10% and 40%. The longer term returns only varied between 13% and 21%, which is a great result for any long term investor. In reality the returns may vary even more greatly, as was seen in the global financial crisis in 2008, where returns were almost -50% over a year. Nonetheless, as the investment term lengthens, the expected returns still converge to a narrower range. South Africa’s long term history shows that the returns on shares have been around 7% above inflation. Therefore based on our current level of inflation, a long-term average return of around 13% per annum appears reasonable.

Aggressive portfolios yield the best long-term returns
In a nutshell, an aggressive portfolio offers the best possible return over the long term. Yes, during the shorter term the returns are volatile, but as an investor, you only run the risk of losing your money should you terminate the investment at that time. One might say that when you are invested for the long-term, the short-term volatility and risks are more part of the background noise – unless of course you sell and crystallise (lock in) your losses at that time.

The long-term investment loves the heat!
If we return to our image of the heat in the kitchen, you may think of the kitchen as too hot (if the returns are that unpredictable) and that you might get burnt. However, your long-term investment loves the heat. All you have to do is get your investment in the oven and leave it to do what it does best. The hard work is to decide on an appropriate investment strategy, and then all you need to do is forget about it or at least leave it until the time comes to consider your phasing options six years before retirement. So think of your retirement fund credit as a paint job at the back of your house (something best left alone!) and rather go and catch up with your friends. It appeals to the lazy genes in all of us – right?

Sanlam Life Assurance Company (Ltd) is a licensed financial services provider.