Playing the long game
Short-term thinking and unrealistic expectations are headwinds that risk driving investors’ plans off course.
Many investors do not realise how much they need to save or for how long, and will face financial challenges in later life unless they adjust to the new reality of a world of low interest rates.
Those are among the key conclusions of a new study by Schroders of 20,000 private investors around the globe. The survey found that private investors are often impatient when it comes to investing their money, with shorter time horizons and more immediate goals trumping the potential for long-term gains. On average, investors expect to hold their investments for a little over three years, which the study observes may be “fine for cash and certain types of bonds”, but that it “will often prove too short a time period to counteract the volatility associated with equities”.
A timeframe of five to ten years should be viewed as the minimum for equity investing, on the basis that it allows investments to ride out the ups and downs of a normal market cycle. This is backed up by seperate analysis by Ritholtz Wealth Management of the S&P 500 over nearly 90 years, which shows the benchmark US index recording positive returns across 88% of all five-year periods. That figure rises to 94% for ten-year periods, while there has yet to be a negative return over a 20-year timeframe.2 Despite this, the Schroders' study found that only 33% of UK investors hold their investments for more than five years.¹ Clearly, the long-term message is going unheeded by many investors.
Notwithstanding this short-term outlook, the need to produce an income is a powerful motivator for investing. Most people are investing to generate an income, either for now or for the future. Respondents gave three main reasons: to supplement their pension, to re-invest income to grow their portfolio, and to supplement their salary.
However, the study highlights varying degrees of understanding about the different elements involved in building a pot of money to generate an income. While it showed that people have realistic expectations of how long they will live in retirement, it also revealed that some greatly overestimate the returns that might reasonably be generated in the current climate.
The study found that, on average, UK investors expect to generate an income of 7.5% a year – double the FTSE All-Share’s current 3.75% yield. Globally, people expect their investments to return 9.1% annually, which is far higher than the MSCI World Index yield of less than 3%. Millennials have even more unrealistic expectations, with a minimum desired level of income of 10.2% per year, compared to 8.4% for investors aged 36 and over.1
This worrying misapprehension about realistic returns is likely to have a profound effect on long-term savings behaviour. Compounding at an annual rate of 9.1% over 20 years, savings of £200 per month would build a sum of £135,286. At a more realistic 4%, however, the total only comes to £73,354.1
Divorced from reality
Looking back at historic interest rates and market returns provides a stark reminder of how times have changed, and how disconnected some investors are from the new reality. For instance, UK interest rates hit double digits some 30 years ago, and stayed there or thereabouts until late 1991, with a peak of 14.8% in 1989.3 In contrast, interest rates are now expected to stay close to zero in the UK, eurozone, US and Japan for some years. Indeed, markets are currently assuming that UK interest rates will not rise until 2020. Against that backdrop, it seems that many investors’ expectations belong to a bygone era.
With interest rates around the globe stuck below 1%, achieving an annual return of 8% or 9% is a near impossibility without taking on significant levels of risk, says the report.1
“Current markets are highly uncertain and, with asset values at elevated levels, we need to accept that we are in a lower-return world,” says Howard Marks of Oaktree Capital. “Investors need to sit it out and wait, but ensure they are invested in the right places and with the right people to enable them to exploit any above-average opportunities. The market will not give you higher returns just because you need them.”
1 Schroders Global Investor Study 2016
2 Ritholtz Wealth Management, http://awealthofcommonsense.com/2015/03/whats-considered-long-term-in-the-stock-market/, 22 March 2015.
3 www.bankofengland.co.uk,18 October 2016
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The opinions expressed are those of Howard Marks of Oaktree Capital and are subject to change at any time due to changes in market or economic conditions. This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any strategy. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.
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