Long-term investing, in concept, is very easy to understand. The strategy of committing capital to a portfolio that is designed to meet your needs in the future is a good strategy. There is nothing overly complicated in understanding that and history, as a guide, confirms the tremendous wealth creating opportunity that exists for those willing to take a long-term approach when investing in risk assets such as stocks. But, to leave the conversation there seems a bit disingenuous. If it were truly that easy, more people would have success investing in capital markets. So why do so many investors struggle with it in practice? The truth is, it’s way harder than most people realize. Here are 3 reasons why:
Having a long-term time horizon doesn’t exclude you from dealing with short-term chaos and uncertainty.
The belief that you can declare your portfolio as a long-term investment and that declaration will magically insulate you from any short-term chaos, is simply false. In fact, it’s the opposite. You will be forced to navigate all the near-term hurdles that trigger pullbacks, corrections and bear-markets as you wait for your timeline to materialize. For example, the current market narrative shapes up like this:
- Evergrande – one of the largest property developers in China is in financial trouble.
- September seasonality – historically, September is a poor month for stock returns.
- Valuation concerns – trepidation that stocks are too expensive.
- The Fed – details of tapering and interest rate policy.
- U.S. debt ceiling – stalemate in Congress yet the U.S. needs to authorize higher borrowing limits.
- Inflation – just how transitory is it, really?
- Increase in the corporate tax policy – the impact to earnings could become material.
- Covid is still in play – the pace of economic recovery remains in question.
The reality is, there will always be something for investors to overcome. That is why investing over longer periods of time has the potential to be so lucrative.
Stock prices and business fundamentals get disconnected from one another.
We have written previously about how the market is a discounting mechanism because it prices today what it believes the future will be worth. This can create dislocations in which a stock price is marked to market, up or down, based on just about anything other than the actual business fundamentals. And, once a negative dislocation occurs, it can take time before the market fully appreciates the underlying business operations and reflects that in the stock price. Should we really be that surprised considering the marketplace is a melting pot of investors, traders, speculators and short-sellers all with competing goals, agendas and timeframes?
Volatility is perceived as absolute risk for long-term assets.
The secret is to understand that volatility is not absolute risk for the long-term portion of your portfolio. It is the short-term portion, assets needed inside a couple years, where volatility more closely equates to risk. This makes sense considering assets earmarked for long-term needs have time on their side while assets set aside to cover near-term liquidity needs should not be exposed to potentially extreme price movements. But many investors confuse this fact and let recency bias (weighting recent events greater than historical ones) manifest into fear and shake them off of their long-term investment goals.
In the end, success comes from structuring your portfolio to meet your near-term liquidity and preservation needs while committing investment to your long-term goals as well. It is crucial to get this framework correct because it allows each portion of your assets to work towards its respective goal – regardless of whether you are working age and saving for retirement or already retired and making regular withdrawals from your portfolio. Once the framework is in place, flexibility and course correction will, at times, be needed but during periods of volatility and market hysteria do not extrapolate fear throughout your entire portfolio. Instead, use it as opportunity.