What are the benefits of adding several decades to your investment horizon?
By Gregg Wolper, a senior mutual-fund analyst with Morningstar.com.
It may be heretical to note that in an investment sense, 10 years is not an eternity. Yes, as an alternative to the all-too-common focus on one-year returns or other short stretches, a 10-year measure provides welcome perspective. It's apt to cover more than one market cycle and a variety of macroeconomic environments. We here at Morningstar often cite that period for such reasons. But for an individual investor, there are benefits to thinking far beyond a mere decade. How about 30 or 40 years?
It's understandable why most people don't peer decades into the future. For a 22-year-old just graduating college, even turning 30 seems eons away. For new parents, the main challenge consists simply of getting the baby to stop wailing. And for others, the idea of a 30- or 40-year time horizon is more likely to conjure up thoughts of aching joints than of happy investment returns. Even when people do turn their attention to the distant future, they're not likely to expect to own the same investments they hold today. After all, by the year 2052, say, an asteroid could have struck the earth, and the handful of us remaining alive will be wandering around a scarred landscape in ragged clothes and carrying battered grenade launchers. At least, that's what you learn at the multiplex.
In fact, it's not uncommon for people to own the same fund (or stock) for decades. And if one has the good fortune to enjoy an average life span or more, an investment horizon could last as long as 50 or 60 years. That doesn't mean investors should ignore prudent allocation advice; short- or medium-term goals deserve appropriately low-risk investments, and reallocations over time make sense. A stock-fund allocation that was appropriate at age 35 probably isn't at 75. But that 75-year-old might still own some stock funds. And the bond funds that will dominate his or her portfolio at that stage could be the same ones bought nearly half a century earlier. For long-term money that's not specifically targeted for a house or college, consider letting your thoughts stretch way, way out.
The important thing is to recognize just how lengthy the long term really is. Thinking of your investment horizon as a very long arc has a number of benefits.
The Power of Dividends
With a limited investment horizon, the idea of getting a 2% or 3% dividend yield from a stock or stock fund may not have much impact. But as the time period under consideration lengthens, the compounded numbers add up. Over 30 years or more, the difference between even a modest dividend and none can no longer be ignored. It doesn't make a lousy stock or fund worth buying, and dividend levels aren't set in stone. But extending your time frame helps magnify the power of dividends.
Helps You Relax
Suffering through downturns can be hard on all but the most hardened investment veteran. If a reversal extends to a year or more, the idea of shifting all your money into short-term CDs or ultrashort bonds can be tempting, even if you know--in vague terms--that you have time to recover. But if you've truly absorbed that your investment horizon extends many decades, it's easier to accept that a one-year downturn likely isn't the catastrophe it feels like at the time.
Encourages Deeper Consideration of Advisor's [or Fund's or Share's] Qualities
If you think you might own a fund for 30 years or more, you'll pay close attention to the source. After all, it's not likely that the same individual will be running it when we pass this century's midpoint. Of course, you can sell a fund if the manager changes and the replacement doesn't impress you. But it would be easier--and cause fewer tax issues--if you could continue holding the same funds for your long-term goals. Owning a portfolio managed by a reliable, shareholder-friendly advisory firm that keeps its focus on investing rather than marketing increases the likelihood that the fund will still be a keeper many years down the road.
Boosts Your Attention To Cost
It can be easy to ignore high fund costs for a couple of years, especially when a fund is pumping out juicy returns during a strong rally. But if you think you'll be paying that steep fee year-in and year-out until 2050 or so, you might think twice. That's a good thing.
Reduces the Temptation to Capture Short-Term Trends
If a decade is your definition of long term, it might be tempting to shift money around in an effort to take advantage of what seems likely to outperform in the next couple of years. That's 20% of your time frame. But with an extended time horizon in mind, such tactics won't seem worth the effort. You might feel confident in your ability to forecast the next few trends, but how about your skill at predicting such patterns consistently well over three decades or more? Just the thought of it is exhausting. Anything that steers investors away from a strategy of rapid, trend-seeking moves is welcome.
See the attached pic from the Share Selection course, highlighting time power, and of costs and dividends...
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Taking a truly long-term perspective does not mean you must own the same fund [or share] forever. Of course you should make adjustments if your personal circumstances change or if the funds change. And, to repeat, the advice to extend your investment horizon to several decades applies only to money that has been relegated to the long-term category and also doesn't have a specific end-date such as the time a current 5-year-old will enter college. So, let your investment thoughts wander well down the road. And, just in case, stock up on sturdy clothes. If that Hollywood-style apocalypse does occur, times will be tough, but there's no reason we should have to wear rags.