By: Tim Bennett
19.08.2019
19.08.2019
When equity markets become more volatile, the right approach to lifetime savings is vital for investors, as Tim Bennett explains in his updated core video.
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Lifetime savings – the risks (2019)
Short-term volatility in share prices can cause investors to react the wrong way by panic-selling. History suggests that this is a mistake. The secrets to long-term stock market success are discipline and good planning rather than dangerous attempts to time the market’s inevitable blips.
Background
It is worth remembering why we invest over the long-term as these reasons don’t change whether the market is rising or falling.
If, for example, we want to achieve financial independence once we stop work, then we might set a savings target – here £1m. This may sound like a lot, but it can be achieved with disciplined investing, over a sufficiently long time period, if we also get a decent average growth rate and follow the right approach to volatility.
How will I get there?
The challenge is to create enough long-term opportunity to get to a decent sum at the end. Whilst cash has a poor history of returns, shares have tended to do much better.
Let’s look at some comparisons to make this point.
FTSE All-Share versus cash
If we look at £25,000 invested at the start of the worst bear market in most people’s living memory, we can see how effective long-term equity investing can be, even after a poor start.
The temptation, over the first few years, would have been to bail out and sell shares as the green equity line crossed below the red cash one. Some investors did just that and will have regretted that decision within a matter of a few years. The volatility of the equity line subsequently shows that they may have been tempted to sell after that too – equity markets can dip sharply sometimes. However, take a long-term view and the markets have tended to recover any short-term losses and then go on to achieve new highs. They also tend to beat cash comfortably. That is why staying power is so important as an investor.
Even a loss of two-thirds of the original investment within a few years in the early 1970’s did not prove catastrophic, provided you stayed the course subsequently.
We can look at this another way – by adjusting for inflation.
We can look at this another way – by adjusting for inflation.
Inflation-adjusted?
This time the chart looks at the purchasing power of your money, taking inflation into account. The end amounts are a lot lower because inflation erodes buying power over time but the gap between the two final amounts, in cash versus shares, is still stark.
Total returns basis?
So far, we have looked at a “capital only” scenario. But what if we assume an investor reinvests dividend income, rather than spending it? Now the first chart looks rather different in terms of the end numbers because reinvested income has a powerful effect when compounded over time.
How much do I invest?
Anyone looking to build lifetime savings over the long-term, with the right approach to short-term dips, will wonder how much they should be investing in the equity market. This depends. The way to identify the amount is to set up a rainy-day fund and then identify foreseeable calls on capital -spending commitments that will arise over the next 5-7 years. Once those have been provided for, the bulk of your remaining savings can be left in equities.
If you would like to discuss some of the key principles raised here in more detail, please contact an Investment Manager, or email me on [email protected].
