Why Focusing on the Long-Term is Smart Investing

After living through the market crashes following the dot-com and housing bubbles, equity investors can be forgiven for feeling a certain amount of apprehension regarding any positive returns their portfolios may have experienced since 2009.  Despite the multi-year trend towards a strengthening economic environment, most investors seem predisposed to focus on potential negative short-term outcomes rather than the broader overall positive long-term trend.  It just seems to be human nature that a certain part of our brain is always waiting for the other shoe to drop.

These feelings of impending disaster are reinforced by our inability to escape the 24-hour news cycle.  Unfortunately, one of the lessons that some commentators and networks seemed to learn in the aftermath of 2008 was that short-term money can be made by predicting the next apocalypse.  You only need one correct call to be hailed as the next talented prognosticator, and the bigger and bolder your prediction is, the more airtime and internet clicks you likely will receive.

Whether the source of these feelings of unease is real or imagined, managing the accompanying emotions can be challenging for investors.  Much like the prescribed treatment for motion sickness, we recommend investors focus on the long-term horizon rather than the daily gyrations of the markets and economy.

A look back at investment returns since the Great Depression illustrates the benefits of maintaining such a focus.  The following table shows the historical number of negative returns from the S&P 500 over calendar-year, rolling one-, five-, and ten-year periods.

*Source: St. Louis Federal Reserve

During this 89-year period, an investor in the S&P 500 had about a 27% chance of experiencing a negative return in any given calendar year.  However, over longer holding periods, the probability of a loss declined quite dramatically.  For instance, over a five-year period, that probability of loss is halved, as investors experienced a loss only about 13% of the time.  As we increase the time horizon to ten years, the probability of a loss over these past time periods declined even further to little more than 6%.  It’s worth pointing out that each of the ten-year periods that experienced a negative return included either the Great Depression or the Great Recession, demonstrating just how catastrophic an event must be to generate negative returns over a ten-year period.

Of course, investors generally are not investing exclusively in the S&P 500. Rather, they typically own diversified portfolios of equities, fixed income and other asset classes.  While most asset classes do not have as much long-term historical data available as the S&P 500, such data does exist for some fixed-income investments.  Using returns for the U.S. 10-year Treasury Bond as a proxy for a fixed-income allocation, we can build a 60% Equity/40% fixed income balanced portfolio and compare this to the returns of the equity-only portfolio.

As one might expect, diversifying into fixed income further decreases the amount of negative calendar year returns an investor would have experienced since the Great Depression.  Indeed, there were no ten-year periods in which an investor would have experienced a negative return.  Furthermore, the likelihood of any individual calendar year return being negative declined from 27% to 17%.

While we must always remember the investment adage “past performance is no indication of future results,” the return information presented above hopefully lends some credence to the benefits of investing in a diversified portfolio of assets over a long-term time horizon.  A properly diversified portfolio is designed to temper the volatility inherent in any individual investment.  This, in turn, should smooth the path for investors as they rely on their investment portfolios to help them meet their personal long-term goals.  Of course, any individual year can present a unique set of challenges.  Nevertheless, we believe that investors that focus on long-term growth through portfolios that participate in continued economic progress and innovation will continue to prosper in the future.