Investing’s a marathon not a sprint

Until the recent Coronavirus crash, stock markets had generally been kind to investors over the last decade, rising steadily with little volatility in between. The stock market plunges of March 2020 serve as a stark reminder that investment doesn’t come without risk, but don’t let that keep you in cash.

The risks in cash

There are risks involved in not investing. The UK regulator, the Financial Conduct Authority, recently raised concerns that retirees were taking the 25% tax-free lump sum from their pensions and keeping it in cash as a safety net. The problem with this approach is that with savings rates at all-time lows, inflation will gradually erode that pot over time. Even if inflation sits at just 2% - the Bank of England’s target – an investor sitting in cash would lose one-third of their buying power over twenty years.

Looking back (and we must always bear in mind that past performance is not a guide to future performance) even with difficult periods, such as the Financial Crisis or the technology bubble burst, stock markets have delivered a return in excess of cash and bonds over time. In spite of the various dramas, the Barclays Equity-Gilt study – drawing on data since 1899 - shows that over a 10 year period stock markets are 91% likely to beat returns on cash and 77% likely to beat returns on bonds. Risk is part and parcel of investing. It is the reason that investors generally receive higher returns from the stock market.

Embracing the opportunities

Volatility can also bring opportunity. In everyday life, when something is available at a cheaper price – from clothing to electricals – we rush to buy it. The stock market has the opposite effect. Investors decide that if no-one else wants it, they don’t want it either. This means lots of investors will often exit the stock market at the first sign of trouble. They see volatility as something to be feared.

It is likely to be more remunerative in the long-term to view it as an opportunity, much like being able to get that flat screen television at a reduced price. It’s the same product, just a whole lot cheaper. Many expert investors will decide the companies they want to own and then wait. When the price falls to a level they deem reasonable, they’ll buy.

Looking to the longer-term

However, in order to make risk your friend, you need to take a long-term view. While stock market theorists will define risk as volatility – the extent to which the price of an asset moves around – for most investors, the real risk is permanent loss of capital. As such, you need to be prepared to sit tight during periods of volatility, rather than crystallising losses by being forced to sell.

This isn’t always easy. Behavioural finance suggests that losing money makes us feel twice as bad as making money makes us feel good. Staying invested through the dips is both very important and very difficult, requiring us to set aside some uncomfortable feelings. However, the potential returns are worth it. Data from TD Ameritrade shows that being out of the market on the 50 best days from 2000-2019 would have seen investors experience a compound annual loss of 5.5% compared to a compound annual gain of 6.1% for those who stayed invested throughout.

Investors also need to remember the impact of dividends. During difficult times, companies may still pay out dividends, which can provide some compensation for falling share prices. Again, investors need to stay invested to earn those dividends, so facing down turmoil rather than reacting to it is likely to be a better strategy.

In recent times it’s been the Coronavirus pandemic, but the reality is that markets may be derailed by anything from a White House Tweet to an earthquake in Brazil. Economist Paul Samuelson once suggested that stock markets had predicted nine of the past five recessions. In other words, they don’t always reflect reality. Risk needs to be managed, certainly, but in the long-term, it can be an investor’s friend.

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