At the very heart of investing is the concept of the risk/ return trade off. This means that if someone does take more risk, then they should be rewarded with higher returns over the long term. And it’s the timeline that’s vital here given you have to take the investment risk into account i.e. that the value of your portfolio can go down, as well as go up, and that’s particularly the case in the short term.
Taking more investment risk should mean that you will be able to grow your investments sensibly. Investing at annualised returns of 7% should see you double your money in 10 years. If you’re investing at 3%, it would take 20 years to double. And while that 7% comes with a lot more risk, at least your money hopes to outpace inflation, which in the last three months of 2017 (as measured by the Consumer Price Index) was also around 3%. A headline inflation rate of 3% and investment growth of 3% means that your spending power just remains the same.
We each have our own personal take on investment risk, and we are absolutely not advocating that everyone takes the maximum level of risk. Some people are naturally more comfortable taking higher levels of risk than others.
Those who are more confident (and even then probably never completely so) are often of that view simply because they are more used to seeing their performance fluctuate, sometimes violently, over particular periods. They also realise that when markets fall, they do recover – it’s again a matter of time.
Investors without that experience under their belt can be lulled into a false view of reality by market trends and that could easily have happened given the current market backdrop. Here, looking at the S&P 500 as an example, the market has continually become less and less volatile over the last few years. 2017 beat all the records given the stockmarket only fell by 1% on eight of the 252 trading days across whole year.
This period of minimal market movements will come to an end – something will eventually tip the market into a period where prices move by more than they do now – it’s rather a question of when rather than if.
While past performance and future returns can and do diverge, the theory behind this pattern is that, over time, the level of market movements will revert/ return to the mathematical middle ground. Once you have your head around this, it can become ‘easier’ to accept what’s happening in markets at any one time, that it’s not going to last for ever, while reinforcing why the words ‘long term’ are important.
It also helps you understand why 7IM talks about ‘targeted returns’ – the percentage returns that, depending on your risk profile, we are aiming to achieve for your portfolio over the long term. By that we mean at least five years, although it is better to look at an eight to ten year timeline. It’s a number that we hope helps with your financial planning as at least you have a guide to what you can expect your portfolio to achieve. And it’s not a number that I know of any other investment managers providing so publically.
I have long been an advocate that time in the market is your friend, but hopefully now you’ll understand a bit more about why a long time is important. It means (a) you can take a level of investment risk that you can become more comfortable with to support portfolio performance and (b) helps you manage your own expectations about performance. And if you realise the benefits of more investment risk in theory, but need some help realising the potential for your portfolio, you can always reach out to a professional as to what this might mean for you.
All this should also help you spot the scams, as well as be aware of any potential bubbles. An investment that looks very attractive in terms of the returns being mooted, especially in the short term, probably comes with risks that, quite frankly, you should not be prepared to take. We’re talking about investing after all…not gambling!
Justin Urquhart Stewart
Co Founder and Head of Corporate Development
Seven Investment Management LLP is authorised and regulated by the Financial Conduct Authority. Member of the London Stock Exchange. Registered office: 55 Bishopsgate, London EC2N 3AS. Registered in England and Wales No. OC378740.
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