We encourage people to invest for the long term. But how long is long term and what does this mean for investment decision-making? Wanita Isaacs offers some thoughts on this topic.
What do we consider long term?
At Allan Gray we take a four-year view when selecting shares to invest in. This typically allows enough time for our value investing approach to pay off. If you are considering investing in the Allan Gray Equity Fund, having four or five years to invest means that you are less likely to be disappointed. However, your return increases exponentially the longer you invest. Graph 1 shows the growth of an investment in the Allan Gray Equity Fund after 5, 10 and 15 years, if you had invested R10 000 since inception in 1998.
What are your other options?
If you have a shorter time horizon, more stable investments present less of a risk, but may have lower potential returns. For example, asset allocation unit trusts, which invest in asset classes such as shares, bonds, money markets and offshore, generally fluctuate less than equity-only unit trusts, and may be more suitable if you have a medium-term time horizon.
A money market unit trust, which aims to preserve capital while delivering higher return than you might get from a bank account, might be suitable if you need to access your money in the very short term. However, very stable investments usually do not keep up with inflation over time and are therefore best suited for investments of a year or less.
Once you have selected a unit trust to match your needs, it is important to stay invested in that unit trust without withdrawing or switching prematurely (see 'What is switching?' in Quarterly Commentary 1, 2014).
Thinking long term means planning for the future by making appropriate investment decisions based on how long you have to invest for each of your goals, and how much risk you are prepared to stomach over your investment period.
Successful long-term investing involves:
- Identifying your goals
- Selecting appropriate investments based on your time frames
- Making sure you do not delay starting to save and that you contribute enough
Why are goals important?
Identifying your specific goals allows you to determine your investment time frame. While your short-term goals will naturally feel more urgent, giving priority to goals which are further away (such as saving for retirement) will, through compound return, give you a better chance of reaching them, while making the lowest contributions.
How to select appropriately
Your time frame, and your ability to tolerate investment fluctuation, determine the type of investments you choose. For example, investments such as shares, which have the potential for high returns, tend to fluctuate more. Drops in value are on paper only, unless you sell your investment when it has lost value. This means that these investments are suitable if you know you will not need to access your money, and you are able to stomach some significant ups and downs, with periods of underperformance that may last for years.
The sooner, the better
Each month that you put off saving, in favour of spending, increases the amount that you will have to save in the remaining months. For example, if investments are returning 9% per year and you need to meet your objective in 10 years' time, delaying saving for just 18 months increases the amount you need to save per month by more than 25%. If your time frame is five years, an 18-month delay means you need to increase your monthly amount by more than 50%.
To give yourself the best chance of reaching your goals, start investing as soon as you can, and take a long-term approach.