A New Year’s resolution for investors: Focus on the long term

IMCO’s CEO says ‘bah humbug’ to predicting near-term events and focuses instead on generating long-term investment success

Traders work on the floor of the New York Stock Exchange during morning trading on Dec. 14, 2023, in New York City. Photo by ANGELA WEISS/AFP via Getty Images files

By Bert Clark

This is a time of year marked by many traditions: the World Junior Hockey Championships, Christmas, Hanukkah, New Year’s and, of course, predictions about interest rates, gross domestic product growth, inflation and stock-market performance for the coming year. For those who like to speculate about these things, ‘tis the season.

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Unfortunately, accurately predicting near-term macroeconomic events and stock-market performance are very difficult things to do. Consider the magnitude of economic and capital-market changes in the past few years. Investors went from worrying about a “lower for longer” world, to navigating one of the biggest drops in GDP, employment and the stock market at the outset of the COVID-19 pandemic, to riding a wave of coordinated fiscal and monetary stimulus, to worrying about stagflation and the highest interest rates in decades. Who could have predicted these events in advance?

This time of year, most investors should, like Scrooge, say “bah humbug” when it comes to predicting near-term events. Instead, they should focus on leveraging much more reliable strategies for generating long-term investment success.

It’s called “long-term asset mix” for a reason

Investors should focus on their long-term asset mix as opposed to trying to predict how asset classes will fare in the near term. That’s because asset mix has been found to account for more than 90 per cent of the variability in investment returns.

Long-term allocation to equities, credit, infrastructure, real estate, bonds and cash should only be altered if there has been a material change in either the investor’s personal circumstances or the long-term outlook for asset classes.

Investors with a longer time horizon and stable liquidity requirements can invest more in growth-oriented assets such as equities, credit, infrastructure and real estate and less in lower-risk assets like bonds and cash. In the near term, growth assets are subject to much greater volatility of returns, but they should generate higher returns over the long term.

For example, US$100 invested in each of 10-year U.S. Treasuries and gold in 1928 would have been worth less than US$10,000 by the end of 2022, but US$100 invested in the S&P 500 would now be worth more than US$600,000.

Invest to your advantage

Investors should only focus on trying to outperform in places where they have a real investment advantage. Many smaller investors look to outperform by employing strategies that are easily accessible: picking stocks or buying mutual funds that do this for them; or trying to time the markets, by increasing or decreasing the amount they have in the markets at any given point in time.

Picking stocks is difficult for most investors, even professional funds. For example, the SPIVA scorecard (S&P indexes versus active funds), which has tracked the performance of actively managed funds versus benchmarks for 20 years, shows that most active funds in all categories have underperformed their benchmarks over the longer term.

Timing markets is equally hard. Morningstar Inc.’s annual report Mind the Gap, which tracks the returns generated by investors versus the funds in which they have invested, regularly confirms that investors on average earn less than the funds in which they invest, in large part because they mistime buying and selling the funds.

Real advantages include a longer investment time horizon, a greater tolerance for illiquidity, the ability to access asset classes at a lower cost, operational expertise to create value and strong relationships with other investors that have origination advantages or operational expertise. These are advantages that typically require the scale that only very large institutions have.

If an investor does not have such advantages, they should seriously consider investing in passive index strategies. The reality is that even for the average successful investor, the vast majority of returns will come from being invested in the broader market, as opposed to outperforming the broader market.

Know what you need

Investors need to understand their liquidity requirements to avoid selling during times of market turmoil. This crystalizes losses and undermines the strategy of investing in growth-oriented assets.

Long-term investors should be positioned to “rebalance” into depressed growth assets such as equities and credit when markets materially decline — which they regularly do. Remaining invested in the markets over long periods of time can also help maximize the impact of compounding, which Albert Einstein called “the most powerful force in the universe.”

Costs matter

All investors should focus on costs. They translate directly into net investment returns. Even for many smaller institutional investors, costs can have as significant an impact on total returns as outperforming within asset classes, according to research by CEM Benchmarking Inc.

For most investors, focusing on costs means investing in passive strategies when they don’t have a high level of confidence that they have any investment advantage and simple tax planning (such as using registered retirement savings plans and tax-free savings accounts).

‘Tis the season for short-term investment predictions. It’s fun to do, but investors with a long investment time horizon should adopt strategies shown to generate stronger long-term investment returns.

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