investment basics a long-term approach to investing For financial advisers only

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1 investment basics a long-term approach to investing For financial advisers only

2 investment basics a long-term approach to investing Investors can often find it difficult to remain patient and disciplined when faced with market movements that go up and down. Here, we present some reasons why it is beneficial to do so, and why taking a long-term approach to investment can often be the soundest approach. 2

3 a long-term approach to investing A long-term approach to investing usually produces the best outcomes for investors. Time in the market is more important than trying to time the market. For most investors, it is generally better to remain invested for a long period than to attempt to guess market movements and buy and sell. Taking a long-term approach is in general more likely to enable investors to achieve their long-term objectives. The next line up, labelled 3 years shows the range of returns they would have received when investing for any three year period, for example from 1971 to 1973, or from 1972 to 1974, or indeed any 24 month period until the end of August As the graph shows, longer periods of investment tend to produce a more favourable range of returns (the lines are shifted toward the right as you move up the graph). This suggests that if the investor s financial plan allows it (for example, they do not require the cash soon) they should in general expect a better investment outcome by holding their investments in the market for longer periods. The graph below shows the range of returns that an investor would have experienced investing in global equities had they invested for different numbers of years, for any period between 1970 and The line at the bottom, labelled 1 year shows the range of returns they would have received when investing for any one year period, for example from 1971 to 1972, or from 1972 to 1973, or indeed any twelve month period until the end of August Some of these one year periods had a loss (shown in light green) and some a positive return (shown in dark green). a long-term approach to investing can tend to improve range of returns in global equities 15 years Continuous period invested 13 years 11 years 9 years 7 years 5 years 3 years 1 year Range of price returns, MSCI World Index (%) Past performance is not a guide to future performance. The value of investments can go down as well as up and is not guaranteed. Investors may not get back what they put in. Source: Quilter Investors, information from Bloomberg, as of 16 Sept Range of rolling annual returns, MSCI World Index, monthly data from Sept

4 RIDING OUT DRAWDOWNS Drawdowns are when the market price of an investment drops in value. The acceptance of the possibility of drawdowns is part and parcel of investment. An investment is purchased in the hope that it will rise in value and/or generate an income; but unlike savings products (such as bank deposit accounts) which are often guaranteed, the value of investments is almost never guaranteed, and will usually fluctuate, going up and down over time. A problem with guaranteed savings products is that the scope for their value to grow will usually be limited to the interest rates available. Currently, interest rates are very low in most developed markets. This can make it difficult for savers to beat the long-term eroding effects of inflation (the rate at which prices for goods and service are rising). ERODING EFFECTS OF INFLATION Due to inflation, retired people relying on a fixed income find, to their discomfort, that the same amount of money buys less and less every year. Inflation is also a great enemy of savings with a fixed rate of return (such as bank savings accounts). The interest they receive has less real spending power after taking inflation into account. The graph opposite illustrates how the purchasing power of US$1,000 would be reduced over time by varying levels of inflation. inflation erodes purchasing power Purchasing power (US dollar) 1, % inflation 5% inflation 6% inflation Years Source: Quilter Investors. For illustrative purposes only. a historic approach One of the most famous advocates of a long-term approach to investing is Warren Buffett, the billionaire investor based in Omaha in the United States. One of his many simple yet profound statements is: Over the long term, the stock market news will be good. * Buffett made that statement during the height of the 2008 financial crisis, when many were panicking; but he kept his head, and in fact bought shares cheaply during the panic. Looking back over history, the financial crisis of 2008 was not the only economic upset; there have been many, but over the long-term, equity returns have generally been positive (see graph on next page). Most investors would experience better outcomes if they have patience and stick with sound, sensible investments held for the long-term. *Article by Warren Buffett in The New York Times, 16 October

5 equity investments have fluctuated, but trended upward over the long-term 5000 Internet era Quantitative easing era Index level 500 Reagan era Dot.com bubble Euro Crisis, 2011 Oil crisis Black Monday 19 Oct 1987 Financial Crisis, Major market downturns MSCI World index* Past performance is not a guide to future performance. The value of investments can go down as well as up and is not guaranteed. Investors may not get back what they put in. Source: Quilter Investors, information from Bloomberg, as of 17 September For illustrative purposes only. *Logarithmic scale, quarterly prices. Unfortunately, some investors take a short-term approach by over-reacting to market movements. All too often they invest most when markets are booming, and sell out when markets are declining, ending up with the worst of both worlds. It can be far more effective for most investors to stay invested and keep adding funds on a regular basis, even when prices have fallen. By continuing to invest when prices are lower, investors can experience the benefits of dollar cost averaging. When prices are falling, the same amount of dollars will buy more shares, allowing the investor to benefit when prices later rise again. 5

6 COST OF MISSING THE BEST DAYS IN THE MARKET One of the dangers of jumping in and out of the market is illustrated in the graph below. The light green column on the left shows the return (not including dividends) after remaining invested in global equities for the last five years. Investors would have made a return of 38%; in other words, if they invested US$1,000 then they would have ended with US$1,380. However, that assumes the investor had stayed invested for the whole five years. If instead they had traded in and out, they might have successfully avoided some bad market days, but they could have also missed some good days (the days with the best returns). The effect of missing just the 10 best days is shown: the return falls to a mere 3%. Missing the top 25 days would have resulted in a loss of 24%. Missing the best 50 days would have meant a loss of 48%. Good days in the market often follow bad days. In this example, of the best 10 days during the five years, four of them immediately followed down days. The lesson is that investors should take the rough with the smooth, as it is extremely difficult to have one without the other. benefits of compounding Another beneficial effect of long-term investing is the logic of compounding. Albert Einstein is said to have called compounding the eighth wonder of the world. Though there is some doubt whether Einstein actually said this, compounding is certainly a great help to long-term investors. Compounding means reinvesting the gain made from, or the interest generated by, an investment. Returns are thus produced on previous returns, and this can have a very beneficial long-term effect. The graph opposite illustrates the beneficial effects of reinvesting dividends, which are the regular payments that companies may make to their shareholders. The light green line shows the return of global equities if dividends are not invested. The dark green line shows the return if dividends are reinvested. As can be seen, reinvesting dividends can have a very beneficial effect over the long term. It is not easy to remain disciplined and patient, and to follow a long-term approach. But as these examples suggest, there are sound reasons for doing so. The damaging effect of missing the days with the best returns 15 September 2011 to 15 September Price return (%) Remained invested for five years Missed top 10 days Missed top 25 days Missed top 50 days Past performance is not a guide to future performance. The value of investments can go down as well as up and is not guaranteed. Investors may not get back what they put in. Source: Quilter Investors, information from Bloomberg. MSCI World Index, 15 September 2011 to 15 September Cumulative price returns (dividends excluded). 6

7 the beneficial effects of reinvesting dividends MSCI World Index (dividends reinvested) (USD) MSCI World Index (USD) 250 Index level Past performance is not a guide to future performance. The value of investments can go down as well as up and is not guaranteed. Investors may not get back what they put in. Source: Quilter Investors, information from Bloomberg, as of 23 September IMPORTANT INFORMATION You should be aware that investments, unit prices and income from units may fall as well as rise and investors may not get back the amount they invested. Past performance is not a guide to future performance. Where a fund invests in securities designated in a different currency to the currency of an Old Mutual International product or where an underlying fund is denominated in a different currency, investments may rise and fall purely as a result of exchange rate fluctuations. Old Mutual International does not provide investment advice. This material is provided for information purposes only and should not be relied or acted on by the recipient. It is not a recommendation to buy, sell or hold a particular investment. 7

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