The phrase “longer-term” is subjective, as you will see if you search the Internet. Some people believe that a longer-term investment is something held for more than a year, others five years, others ten years and more. However, the concept of investing for the long term remains intact no matter the time period.
If you want an example of a successful long-term investor, you only need to look towards the likes of Warren Buffett. They take a fundamental long-term position in stocks based on long-term prospects, comfortable riding out short-term volatility and fluctuations.
Market timing is not as important
Market timing is not as important when investing for the long term, although it should not be discounted entirely. As humans, we are notoriously bad at timing due to emotions and sometimes unconscious bias. Many investors will chase trends when a share price is rising, ignoring those underperforming but still offering value for money on long-term fundamentals.
For example, an analysis of the US S&P 500 index found that over a 20-year period to December 2019, the average annual return was just over 6%. During that same time frame, the return for an average investor was around 2.5%. This suggests that a long-term (passive?) investment approach can pay significant dividends.
Economic expansion and recession
Periods of economic growth and recession will significantly impact short-term investor sentiment and market movements. History shows that boom times last far longer than recessions on average. This is demonstrated by a recent research note examining the US economy between 1950 and 2022.
During this period, the average recession lasted ten months, leading to a 2.5% reduction in GDP and net job losses of 3.9 million. The average period of economic expansion lasted for 69 months, produced average GDP growth of 24.6% and a net increase of 12 million jobs. While history is no guarantee of the future, it does give us an idea of the average recession and economic boom times.
Reduced transaction costs
Recently, we have seen a significant increase in the number of short-term traders, some of whom manage to post impressive returns. While the introduction of online trading has reduced transaction costs to a certain extent, the more active the trader, the greater their cumulative dealing expenses.
On the flip side, those who invest in the longer term will trade less frequently and therefore, their cumulative trading costs will be lower. Appreciating trading costs when looking at your overall investment returns is crucial.
Avoid emotive decisions
There is a very different mindset between a short-term trader and a long-term investor, with short-term trading tending to involve more emotive decisions. Traders will have their favoured stocks, maybe even unconscious bias toward particular sectors, and when they are out of the market, many will actively seek their next investment.
Short-term traders will look towards trends, while long-term traders will look towards the fundamentals. Even though any investor will have a degree of concern about market movements, as we discussed above with the boom and recession times, as long as the fundamentals remain positive, the share price should eventually reflect this.
Pound cost averaging effect
One of the main features of any financial strategy is that it is improbable you will time any investment or disinvestment to perfection. This is where pound cost averaging comes into play, a gradual increase in your investments which will reduce the impact of short-term volatility.
For example, you may believe a particular share has long-term potential, but the price is impacted by short-term market volatility. If you had £20,000 to invest and the shares were £2, then a one-off investment would see you by 10,000 shares. However, if you were to invest half of your funds at £2, you would have 5000 shares. If the shares fell to £1 and you invested the additional £10,000, buying a further 10,000 shares, you would have 15,000 shares at an average cost of £1.33. Compare this to a one-off transaction, where you would have 10,000 shares at an average price of £2. This is the power of pound cost averaging, which works particularly well with collective fund monthly investments.
Conclusion
There are many different factors to consider, whether you are a short-term trader or long-term investor. It is important to reiterate that just because you are a long-term investor, this doesn’t mean you can’t take a short-term profit or even a loss if the company’s fundamentals were to change. Short-term traders tend to be drawn to overbought and oversold positions. In contrast, long-term investors tend to look more towards the fundamentals, to a certain extent ignoring short-term volatility.