Why successful investors play the long game
Barclays Behavioural Finance team shows you could give yourself a better chance of generating positive investment returns if you build a strategy that’s suited to your needs and then stick to it.
When you invest, you should do so for the long term. This recommendation is made repeatedly by providers of investment products and services, including Barclays. But what does it actually mean, when can we invest for the long term and why is long-term investing better than short-term investing?
In investing – as in life – “long term” can mean different things to different people. At Barclays, we typically consider long term to be five years at the very least. But not all people are able to invest for the long term. It is important that investors consider their own investment time horizons.
Put simply, your investment horizon is determined by when you need the money that you are considering investing: i.e. how long do you have before you lose the ability to choose when to sell? For investors saving for a deposit for a house in the next few years, this length of time is typically short, whereas an investor saving for retirement will often have a very long time horizon. Both types of investor should also consider building up an emergency savings fund that they can access immediately.
Even if an investor has a long time horizon, they may struggle to invest for the long term because of another threshold: their emotional horizon. In times of stress, when the market is falling, our emotional horizon shrinks. If we run out of emotional liquidity, we may be forced to sell to calm our worries. Thus, even with long-term time horizons, our emotions can and often do stop us from investing for the long term. (For more on time horizons, please see our article entitled “The trouble with time horizons”)
But why should we invest for the long term? First, it’s important to appreciate how investing differs from saving. When you invest a sum of money, you do so in the expectation of making a profit, but you may end up making a loss. Indeed, the value of investments can rise and fall and you may get back less than you invested. However, with a savings account, you expect to get back your original deposit, plus interest at an agreed rate.
With investments, there is less certainty – you expose your money to more risk because you want the chance to generate higher returns than could be achieved from a savings account. The price for the certainty afforded by a savings account is the guarantee of a lower value of your savings over the long term, especially when inflation is taken into account. As a result, savings accounts may actually produce less favourable results over the long term, and so be more risky, than investments.
Some types of investment are regarded as less risky than others – government bonds issued by developed countries, for example, are generally considered to be less risky than shares, although investing in government bonds is certainly more risky than holding your wealth in a cash savings account. Moreover, you may be able to lower the overall risk to your investment portfolio by “diversifying”, i.e. by mixing different types of investments so that a fall in prices in one is, to at least some extent (dependent on correlations), offset by a rise in prices in another.
Most funds offer some diversification – they are designed by their managers to spread investors’ money across multiple investments – although they still offer varying levels of risk overall, depending on their objectives and underlying asset classes.
The problem is that even the most well-planned and successful investment journey will probably include a range of peaks and troughs along the way. If an investor can wait for a trough to pass, this is far better than being forced to sell while in a trough and thus realising the loss. Often when the troughs come along, even investors with long time horizons tend to feel they should do something – i.e. sell some or all of their investments – even though the best course of action might be to do nothing at all.
In the field of behavioural finance, this tendency is known as an action bias. Behavioural finance aims to understand how human instincts sometimes cause investors to make incorrect decisions. Barclays has a team of researchers dedicated to the field, and you can find out more about their work by reading “The six life stages of investing”.
Why five years is a long time in investing
Historically, diversified investing for longer than five years has tended to generate greater returns than leaving cash in a savings account over the same period. It is important to note, however, that the data do not show that investing for five years will always produce positive returns; they simply show that this was true for most of the five-year periods over the past century.
It is also important to bear in mind that how an investment has performed in the past, for however long, is not a reliable indicator of how it may perform in the future. There can be no guarantees that the events of the past will be repeated.
If you were to divide the history of the world’s major stock markets into single months, and analyse what happened to a diversified portfolio of shares during each of those months, you would find that the portfolio made a loss for about 40 per cent of the time. If, on the other hand, you looked at periods of five years, you would see losses only 15 per cent of the time. And if you looked at periods of 20 years or longer, you would hardly see any losses at all.
Over shorter horizons there is a large amount of chance in market movements, and this makes it very hard to distinguish skilful investing from pure luck except over the long term. (For more on this and whether we should try to time the market, please see our article entitled “Should I try to time the market?” [PDF, 81.6KB]
What to do next and how Barclays can help
Investing for the long term can be difficult if you feel anxious about short-term volatility along the way. Human instinct means that we all feel this anxiety to some extent, although some people have a higher tolerance for volatility than others. It is therefore important to understand your appetite for risk and the effect your behaviour has on the value of your investments.
It is also important to understand your investment time horizons. Barclays research shows that most investors have achieved better results if they built a strategy that was appropriate to their needs and then stuck to it for five years or more1.
You can read more about good investing habits and how to practise them in our article, “The six principles of good investing”.
If you have a Relationship Manager2, they can put you in touch with one of our Investment Advisers, who can help you build and stick to an investment strategy suited to your needs, circumstances and goals. Please note that if you are in the United Kingdom we cannot advise you on investments. To arrange to speak to your Relationship Manager, please call us on +44 (0)20 7574 3212*.
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