Put 2020 behind you: looking long-term is good for your wealth

2020 was a tough and volatile year but should remind investors of the importance of looking long term rather than being buffeted by a crisis.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

2020 was an unsettling year for even the most seasoned investor. While markets rose overall, there were vast differences from month to month, from sector to sector and from country to country. In such uncertain times, it becomes even more difficult to take an objective and long-term view of markets.

The rise of day trading and the heady gains to be made in speculative investments such as Bitcoin were also a distraction for investors. The appeal of looking long term can wane when there are apparently easy wins to be made in the short term. With this in mind, it is perhaps worth a reminder on why we believe it is better to try and take an unemotional view on markets and to look long term.

Your financials goals are likely to be long term. From retirement to your children’s education, they can be measured in decades rather than years. It expends a vast amount of mental energy to be constantly worrying about markets, asking whether you should be buying or selling. For the most part, events that felt seismic at the time appear as tiny blips in the long-term growth of stock markets.

Trying to time your entry and exit to the market is a fool’s errand – in general, the most experienced investors don’t try it. The ideal scenario, buying low and selling high, is fiendishly hard to do because it is human nature to run with the herd. Investors tend to get nervous when markets hit a period of weakness and may sell. At the other extreme, they tend to feel jubilant when the markets are buoyant and may be encouraged to buy more.

This is borne out by the well-respected annual study by investment consultants Dalbar. It consistently shows that investors tend to underperform the market because they trade in and out at the wrong time. Perhaps more importantly, the most recent study, based on 2019 data, shows that since 1984, the majority of that underperformance (70%) took place during 10 key periods of market crisis1. In eight of those crises, just one year later investors would have been better off taking no action at all1.

Taking a long-term view allows compounding to work its magic for ISA savings.

This was certainly true in 2020. Those who sold out in February and March as markets crashed would have struggled to find the right moment to buy back in. The pandemic remained a threat all year and economic data was, for the most part, dire. Yet markets recovered. This pattern is repeated through history: those who sold out of the FTSE All Share just as Lehman Brothers filed for bankruptcy in September 2008 may have missed the significant rally from February 2009 to April 2010, when the index recovered around 50% of its value2.

Another consideration is that trading is expensive. The more an investor trades, the more of their portfolio is lost to trading costs. Unless they are adding real value with those trades (which – as we’ve suggested above - is difficult), it could hit investor returns.

Long-term buy and hold investors tend to avoid these problems. To this end, the investment trust structure is particularly useful. With an open-ended fund, the fund manager needs to buy new stocks when there are inflows into the fund and sell when investors redeem. In contrast, investment trusts have a fixed pool of capital.

This means that investment trust managers can buy or sell stocks when they believe it is the right time to buy and sell, not because they need to manage inflows and outflows. It also means they can hold assets that are less easy to buy and sell. This gives a great deal of investment flexibility and proved vital in the volatile markets of 2020.

Taking a long-term view allows compounding to work its magic for ISA savings. It allows dividends to be paid and – where possible – reinvested; it gives fund managers the freedom to see their investment thesis come to fruition and it introduces some important investment discipline. This was crucial in 2020 at a moment of crisis but is a lesson investors should always carry with them.

1Dalbar, March 2020
2The Independent, September 2018