Investing Basics: DIY Investing for the long term

Even for the most experienced investor, it is almost impossible to pick the perfect moment to enter or leave a market, let alone to select the perfect investment to hold during that period. Christian Leeming explains the benefits of a long investment horizon, and how exchange traded products can help

The trouble is, it’s never clear what would have been best to invest in until after the fact. With hindsight, it may look obvious that equities were heading for a crash in 2008, and that gold would perform well in the turbulent years afterwards.

But in the thick of it, nothing is so clear-cut; no doubt 2022’s best choices will be crystal clear, just as soon as 2023 rolls around

Instead of trying to ‘win’ at investing by making the perfect move at the perfect moment, investors should take confidence from the overwhelming evidence that, as the well-known saying goes, ‘timing the market’ rarely produces the kind of returns achieved by ‘time in the market’.

‘timing the market’ rarely produces the kind of returns achieved by ‘time in the market’

Investors who have remained in the market year after year, and crucially, who have diversified across asset classes, have typically built their wealth.

Einstein famously described compound interest as “the eighth wonder of the world”, and even seasoned investors can fail to fully understand the importance, over time, of achieving just another 2 or 3 percentage points of return and how this will add to portfolio growth.

JP Morgan’s research shows long-term investing usually produces positive results, and that short-term volatility and underperformance, which makes investing risky, can be overcome if an investor diversifies and commits to the long-term.

They state that between 1980 and 2016, in 30 out of these 36 years, markets recovered from drops and made positive returns.

‘the return on cash in the bank is only slightly better than cash under the mattress’

By contrast, the same research showed that one long-term underperforming position has been cash.

Over extended periods, the return on cash in the bank is only slightly better than cash under the mattress.

Between 1899 –2017 – that’s 118 years of data – the annualised return on cash was 0.6%, compared with equities, which return 6.6%.

Looking at cash returns over a shorter period, in the 18 years since 2000, which include the 2008 financial crisis, the research found the annualised return on cash has been -0.6%, versus a 4% return on equities.

Read ‘Why it is important to diversify your investment portfolio in order to protect it’

What is ‘well diversified’?

What are the elements that define a well-diversified portfolio? And how can they be achieved?

The most important factor in diversifying is to choose assets that don’t correlate closely; in other words, assets that don’t all respond to market events in the same way. This historically makes for a less volatile portfolio.

One example of a model diversified portfolio would be to hold core long-term investments in equities and bonds, complementing this with alternative investments.

The equity assets might include domestic equities, US equities, Asian equities and world equities.

This equity allocation could be balanced with bond allocations. Then there are the specialist sectors such as gold, precious metals, industrial metals and broad commodities. Commodities often have a low correlation to equities and bonds, making them potentially a useful tool for portfolio diversification.

Using ETPs to diversify

Before the advent of the Exchange Traded Product (ETP), it was more complicated and expensive for investors to build a well-balanced portfolio, as investors would need to allocate their portfolio to a variety of stocks and shares, which would incur higher transaction and ongoing charges, but would also have the risk of higher volatility.

ETPs are designed to replicate the return of an underlying benchmark or asset, with the access and tradability of a share.

Investors can benefit from the broad diversification of an equity benchmark, gaining exposure to hundreds or thousands of individual securities in a single transaction.

Additionally, the wide range of asset classes covered by ETPs opens up more exotic investment areas which historically could only be accessed by institutional investors (such as individual commodities or emerging markets).

ETPs generally do all this with a lower fee than actively managed funds and therefore compete with traditional index funds on cost. For a long-term investor, lower charges over the long-term will make a significant difference.

Because an ETP tracks a market, it should enable a long-term investor to ride out short-term ups and downs and make the longer-term gains that come with staying invested in an asset class over many years.

For a long-term investor, ETPs can offer a secure and cost-efficient way to gain diversification in a portfolio.