For many of us, the traditional savings account comes to mind when we think of saving. But an investment portfolio could earn you much more. In the long run, your chances of increasing your gains will be greater.
It’s simple: the more time you give your investment to grow, the more likely you are to obtain a handsome return. Two factors contribute to the possible increase: compound return and implied volatility. Let’s dig in.
Compounding works in your favour
When it comes to long-term investing, keep in mind that small streams create big rivers. In other words, in the long run, the amount you initially invested will grow more and more over time thanks to compound returns, which has little effect at first but snowballs over the years. The mechanism that operates is simple: your money first earns you a return that is added to your initial capital.
The subsequent return will add to your initial investment and the gain you made in the previous period. As your capital grows faster and faster due to this return on returns effect, the impact of compounding becomes impressive when done over an extended time horizon!
Let’s look at an example. If you invest $10,000 in a mutual fund with a compound return of 5%1, your gain will be $500 at the end of the first year (5% of $10,000). The following year, your return will be calculated on the basis of $10,500. And so on. After 30 years, according to this example, your capital will have more than quadrupled and could reach nearly $45,000.
Allowing yourself a degree of risk
You can’t invest without risk. But the good news is that when you invest over the long term, the fluctuations affecting an asset tend to cancel one another out and cause its implicit risk to be lower than it would be over a shorter period. This temporal concept of volatility means that, in the long run, you can tolerate risk that you might not be able to assume in the shorter term. In other words, if you have a longer-term investment horizon, you could afford to invest in securities with a higher potential return because they will have more time to bounce back in the event of a capital loss during a market downturn.
The other benefits of the long-term approach include protection from the investor’s number one enemy: emotional decisions! Predicting the market in the short term is difficult and more often than not leads to bad decisions resulting from behavioral biases. Remember to take a deep breath during periods of market volatility. Long-term investments can usually withstand some short-term upheaval without diminishing your chances of making a large gain in the long run. Finally, the long-term approach will also allow you to save on transaction fees but above all it will give you peace of mind, because you already have enough things to take care of on a daily basis!
Whether or not you choose a risky investment, your chances of success increase if you remain realistic and pragmatic. People who invest for the long term are not exempt from the prudent practices recommended to all investors: assess your risk tolerance properly and don’t try to exceed it, have a clear savings goal and stay on track to achieve it, and make sure you stay realistic by keeping to your budget. In long-term investing, portfolio diversification also reduces risk – another concept to keep in mind!
Still not sure? Why not do a simulation of your savings project on the FÉRIQUE Portal? The simulation tool will help you set your goal and take your investment horizon into account. Planning everything else will then become easier.