HOW LONG IS LONG-TERM?
Mark Lister, 27 October 2021
People often ask me if they should be putting their savings or spare money in the sharemarket. My first response is always the same - “when might you need to call on those funds?”
The are many questions a financial adviser will ask to help establish what sort of investment mix is right for you, but I think that one is the most important.
There are few things that determine what’s best for your money more than the time horizon you’re thinking about investing it for.
It’s always dangerous to be definitive, but if the answer is anything less than five years, I tend to believe you’ve got no business being invested in shares.
They’re too volatile, and the risk that you might need to sell or take some money off the table during a rough period is just too high.
If you think you’ve seen (and successfully navigated) one of those periods because you were invested during the COVID-19 recession of 2020, think again.
That was a fairly “normal” bear market in terms of the 33.9 per cent decline, but it happened much more quickly than usual.
The sell-off was all over within five weeks and then a mere five months later the market had recouped all of those losses.
During the previous major decline, the sharemarket peaked in October 2007 but it didn’t bottom out until almost 18 months later in March 2009.
It was a much bigger drop too, with the S&P 500 down 56.8 per cent over that period. After that, share prices didn’t recover to their previous levels until 2013.
Those falls certainly don’t happen every year, or even every decade, but they do happen and none of us can predict when.
Since 1960 the US market has fallen by more than ten percent 31 times. Eight of those times it’s been down more than 20 per cent, and three of those times (1974, 2002 and 2009) more than 40 per cent.
The last thing you want is to be a forced seller at those times.
On the bright side, the market has a faultless track record of recouping any losses and moving on to bigger and better things.
Today, despite all of those ups and downs the US sharemarket is very close to record highs, and the annual return since 1960 has been a very healthy 10.3 per cent. Inflation has been 3.7 per cent per annum over that period.
Investing in shares can be an excellent way to generate an income, grow your capital and protect yourself from the scourge that is inflation.
However, it only works for long-term investors, and five years or less isn’t the long-term.
If your savings is earmarked for a big ticket item over a shorter timeframe, such as a house deposit or wedding, that’s no where it belongs.
Money which you might need soon (and by soon, I mean in the next couple of years) should be in low risk assets, like term deposits. But don’t be fooled, you can still lose money there too, just not in the same way or to the same degree.
The best one-year term deposit rate I can find at the moment is still below two per cent, before tax.
With inflation running higher than that, your purchasing power is being eroded as we speak, which means you’re getting poorer. You’ll get back what you put in, but it won’t go as far when you come to spend it.
Everyone is different, so we should all take responsibility for our finances and do what’s right for us. In doing that, one of the most important things to get your head around is your investment time horizon.
If you’re planning for the genuine long-term, shares are hard to beat as a wealth creator. However, if you might need that money sooner, maybe think twice before diving in.