28 Sep Long-term goals, short-term emotions
There is always a dynamic tension that exists between the sensible well thought out long-term financial goals that investors set in place, often with the help of their financial planner, and the emotions that they are likely to experience in the moment, as markets respond to new information and portfolio values are impacted.
This tension can sometimes be most acutely felt by both the investor and their adviser in the early stages of their relationship when a portfolio either goes down or sideways in the first year or so. However, as much as one would like to start one’s investing experience with markets rising, the reality is obviously not always the case, as newer investors have recently experienced.
From the investor’s point of view, an aversion to loss, the feeling of loss of control and disappointment at seeing hard earned money falling in value can feel unsettling. From the adviser’s perspective it can also be a challenging time, knowing that however sound the financial plan, however sensible the portfolio asset allocation and however much time they have spent providing insight into the up-and-down journey a client will experience, emotions often trump logic when a portfolio shows a fall in value.
At such times it can be useful to reflect on a number of things:
- First, cash is the only investment that avoids losses – but only before inflation – but its low long-term, after-inflation returns are unlikely to allow most investors to meet their financial goals, hence the need to add equities and bonds into the asset allocation. Do not be fooled by today’s high cash rates relative to recent years; they are a chimera for long-term investors and are not a substitute for a sensibly structured long-term portfolio designed to meet long-term goals. Do not be tempted by them. Use cash for your cash reserve, not for your long term portfolio.
- Second, it is the very uncertainty of the shorter-term outcomes of equities and bonds that delivers the longer-term, higher after-inflation returns that most investors need to meet these goals. The longer-term expected returns from a sensibly structured investment portfolio are far higher than those of cash. This is a fundamental principle of investing, that in order to be willing to bear the additional risk of equities and bonds over cash, investors must expect to receive a higher return to compensate them for taking it. If the expected return were not higher, there would be no reason to take that additional risk.
- Third, returns come from markets not advisers, at least those employing a systematic approach to investing that aims to capture market returns. Blame should not be apportioned to an adviser because a portfolio has not gone up in value in the same way that praise should not be heaped on them if it has risen spectacularly! Markets are not predictable in the short term. Stay invested.
- Finally, falls in portfolio values are not losses and have every likelihood of recovering in time. Patience allows the longer-term expected returns to be realised. Avoid emotionally-driven investment decisions that might impact these longer returns.
The chart below provides an insight into the proportion of times that investors in a 60% equity, 40% bonds portfolio have suffered falls in value over different time horizons. Whilst falls in purchasing power (i.e. after inflation) over two years are not uncommon, over five years, which is only a fraction of the time horizon of most investors, the chances of a fall decrease materially, based on data over the 33-year period reviewed.
Figure 1: The likelihood of gains in purchasing power (January 1990 to August 2023)
Data source: DFA Returns Web. Data: 60/40 global balanced portfolio from January 1990 to August 2023, rebalanced annually
If you are a new investor, keep the faith and remain invested for the long term because that is what is required to give yourself a chance of meeting your long-term goals. If you have been investing for some time and been through one or more cycles of market falls and recoveries, hopefully the tension between longer-term goals and short-term emotions will be greatly tempered.
As Charlie Munger, Vice Chairman of Berkshire Hathaway once said: ‘The big money is… in the waiting’
This blog is intended for information purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person. Your capital is at risk when investing. Past performance is not a reliable indicator of future results and forecasts are not a reliable indicator of future performance.
 Global equity model portfolio balanced by global bonds hedged to sterling (full details of market indices used available on request). No costs of any kind have been deducted. For illustration purposes only (see ‘Risk warning’ above)