Taking a long-term approach to investing
Patience may be a virtue, but when it comes to building your portfolio it’s also an excellent investment strategy. A long-term investment perspective requires a well thought out plan of action plus the discipline to stay with the plan. In return, long-term investing offers distinct safety advantages. Here’s why.
Long-term investing tends to focus on quality investments that demonstrate a lengthy and solid financial track record featuring most of the following characteristics.
n Consistent dividend payout;
n Strong balance sheet with low debt to equity ratio;
n Steady revenue and earnings growth;
n Steady stock price appreciation; and
n Focused management track record measured by solid annual return on equity.
While past performance can’t predict future return, these quality investments are usually market leaders in their industry and widely traded. They are well followed by research analysts as well as the business media, and the value of their products or services is usually straightforward to understand and assess. The value of these quality investments isn’t measured overnight, but over time.
The long-term investor will be looking for a diversity of investment opportunities that, taken together, will offer a combination of growth and security. This naturally promotes asset diversification among different investment classes — equities, fixed income and cash equivalents. It also promotes diversity within each investment class.
Diversity spreads risk within the portfolio and limits the potential for loss from any one investment by a substantial margin.
Diversity over the long term also means investors can seek out undervalued investments or growth opportunities that will be risk balanced by the strength of their core portfolio holdings.
The long-term investor avoids speculation on “hot tips” and trying to beat or time the market. A fully invested portfolio that is focused on long-term performance often saves investors from “taking a flyer” that could have major consequences Speculation usually means lost time and money for most investors. A portfolio diminished by a series of speculative investments may never fully recover its asset value and reduce the portfolio’s long-term return on investment.
You’re taking advantage of the “miracle of compound interest”.
A number of financial trends works in investors’ favour when they take a long-term perspective. Compound interest is chief among them. An investor who builds a portfolio over time through a regular investment plan of contributions and reinvested dividends and capital gains (especially in the tax-deferred environment of the RRSP) can dramatically increase a portfolio’s investment value. The longer it’s allowed to work, the higher the return. For example, a $25,000 initial investment supplemented with $5,000 each year and compounding at an average 6.5 per cent annual return will be worth $65,000 after five years, $119,000 after 10 years and $434,000 after 25 years of compounded growth. A long-term investment plan that involves regular contributions takes full advantage of compounding and enables you to make money on the money you’re saving for retirement.
Strange as it may seem, the longer you remain invested in the market, the less risk you may face as an investor. In Canada, the S&P/TSX 300 has experienced its share of short-term volatility but for long-term investors, the average 40-year annual rate of return has been 10.9 per cent.
Investors with a short-term horizon who move in and out of the market are subject to the full forces of daily, monthly and yearly market volatility. Investors with a 10-year or more investment time frame can expect the periodic fluctuations in their portfolio’s value will be smoothed out and the long-term upward momentum of the market will play a more dominant role in determining their investment returns.
Short-term investors must micromanage their portfolios, usually in an attempt to market time their buying and selling in an effort to beat the market. A long-term perspective on portfolio management means not worrying about investment performance on a daily basis. The investments you’ve assembled in your portfolio are subject to review (quarterly or annually) to ensure they are performing according to plan and generating an overall return on invested capital that is what you expect. When necessary, buying and selling to re-balancing the portfolio and asset allocation decisions can be done methodically and not reactively or in haste.
The advantage of a long-term investment approach comes from the knowledge that time is on your side and working for you.
Judy Poole is a financial advisor with Raymond James, and has spent the last 39 years involved in the financial industry. You can reach her at firstname.lastname@example.org. This article is provided as a general source of information and should not be considered personal investment advice. The views expressed are those of the author and not necessarily those of Raymond James Ltd. Securities offered through Raymond James Ltd., member - Canadian Investor Protection Fund. Financial planning and insurance offered through Raymond James Financial Planning Ltd., not a member - Canadian Investor Protection Fund.