Why it’s important to invest for the long term

Periods of stock market volatility can be unsettling for investors but dipping in and out of the market to try to avoid them can have a serious impact on long-term returns.

Attempting to time the market is almost impossible, as no-one knows exactly when markets will rise and fall. That means investors who try to sell before markets reach the bottom and buy when they’re on the up potentially risk missing out on some of the best days.

Buying and holding investments for the long term can help investors avoid making panic decisions when markets are turbulent which could cause them to sacrifice returns.

For example, while past performance should not be viewed as a guide to what will happen in the future, if an investor had put $1,000 into the MSCI World Index 40 years ago, they would since have seen their investment grow to $34,527 today. But if they’d missed just five of the best days over that period, they’d be left with a considerably lower $24,060 – a difference of more than $10,000.[1]

Investing over the long term also gives investors’ money the greatest chance to grow, as if there is a downturn, hopefully their investments will have the opportunity to recover in value in years to come.

The magic of compounding                                           

One of the main benefits of investing over the long term is that there’ll be plenty of time to benefit from compounding.

Essentially, this means that any dividends or interest paid are added to the original investment, with the hope that both these and the initial sum invested will generate growth going forward. Bear in mind, of course, that returns from dividends aren’t guaranteed.

Compounding can dramatically boost the potential returns long-term investors end up with, which is why Albert Einstein called it “the greatest mathematical discovery of all time.”[2]

How volatility can work to investors’ advantage

Investors who are able to hold their nerve during stock market storms and who invest regularly over the long term may find that volatility works to their advantage.

That’s because by drip-feeding money into the market gradually, investors can potentially benefit from ‘pound-cost averaging’. This means that investors purchase more shares when prices are low, and fewer when they are expensive, which helps to smooth out investment returns over time.

For example, if an investor had a lump sum of $1,000 that they wanted to invest in shares valued at $10 each and they invested the full amount in one go, they’d buy 100 shares.

If, however, they invested their money monthly, perhaps putting in $100 a month over 10 months, and the share price fell during this period, they’d end up buying more shares than they would have if they’d invested the full lump sum at once.

It’s worth remembering though, that regular investing doesn’t always reap rewards, as if share prices rise over time, then investors’ purchasing power reduces. What it does help instill however, is investing discipline, as it means that investors commit to buying shares every month regardless of whether prices are low or high.

Stay focused

Investing for the long term may give investors the best chance of yielding positive returns, but this often doesn’t provide much comfort when markets are falling.

Focusing on investment goals and the reasons for investing can help investors ride out any periods of volatility, with the hope that they will ultimately be rewarded for their patience.

However, there are no guarantees, so those who are unsure whether investing is right for them should seek professional financial advice before proceeding.

[1] Source: Bloomberg, Datastream and AXA-IM Research; Note: All calculations done using MSCI indices over the last 40 years ending December 2018. Performance based on reinvestment of dividends.
[2] The Motley Fool,  Change your life with one calculation