The Importance of the Investment Horizon
We cannot predict the markets—or can we? History repeats is an old saying that proves to be true for markets! Markets, over time, follow rules which are scientifically investigated and proven. Therefore, there are three basic things that you have to consider when investing—under special consideration of a long investment horizon:
Invest, invest, invest. Compound interest rate and dividend growth compounding are your best friends.
Don’t panic! You cannot predict the market in the short term, but you can in the long term.
Markets as a whole must rise. Technology is moving ahead and the population is growing, so take advantage of it!
The Compound Interest Rate
Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it.. –Albert Einstein
There is an interesting story to help you understand compound interest: In the third century, an Indian invented the game of chess. The king was impressed and asked him what he would like as a payment for his idea. The inventor answered that he wanted one rice corn on the first field of the chessboard, and double rice corn on each subsequent field. The king thought, “What a modest man the investor is!” What he did not realize is that for 64 fields, a total of 18.4 quintillion (10 to the 18th power) rice corns would need to be paid. This was more than what was available throughout the whole world during that time!
The following example shows 8% annual interest of a monthly USD 100 investment. It can clearly be seen that the compound interest leads to a roughly four times higher return than the simple interest.
The compound interest rate works the same for stocks. Dividends can be reinvested, thereby increasing the value of the portfolio again. This is called dividend growth compounding.
There are many compound interest calculators out there that support you in choosing the best investment for you, such as this one.
The Long-term Market Performance
Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves. –Peter Lynch
Everybody knows somebody who claims to have invested that much in that stock and gained that much. Maybe you are this person yourself. And if you are, do you ever tell people how many investment failures you’ve had and how much money you’ve lost? After all, scientific data shows that in the long term the average asset manager does not beat the general market. Again, this counts in the long term; figures might be different for a limited amount of time or for specialists who are focused on a very special investment area that they know better than anyone else. However, this is true for most financial advisers that give general investment advice to private clients.
Also, the timing of investment is usually overweighted. Consider the worldwide markets. To make it as independent and reliable as possible, look at the MSCI World Index for large and mid caps. Assume someone wanted to invest USD 1,000 every year beginning at the worst point in time to start: before the oil crisis in the ‘70s. When you look at the data, you see that 1969 already started with a negative -5.71% growth. So at the end of the year, if you began investing in 1969, you have lost some money, but you already started 1970 with more money than the person who first invested USD 1,000 in 1970. This difference of USD 942,92 (USD 1,000 - 5.71% * 1,000) gives you an edge of more than USD 20,000 by 2020. What’s important to understand here is that the graph is smooth and clear. Starting to invest regularly as early as possible and not pulling out at bad market conditions is key. Especially in bad market conditions, the dollar will buy you the stocks at the cheapest level. And you know that you cannot pull out right at the top, so either you will pull out too early or too late.
Things are different for large lump-sum investment. Better go with a dollar-cost averaging if you are not absolutely sure that the market is low and you want to invest all money at once. The following example shows a lump-sum investment of USD 100,000 invested in different years. In general, one can say that the investment will make money in the long term. The return depends on the market conditions of the current economic cycle.
It gets even more obvious when you look at more recent data. If you invested USD 100,000 at the end of 2000, you ended up with USD 172,237 in 2017. If you waited to invest the same amount until 2002, you ended up with USD 265,608. However, if you waited too long and invested in 2005, you ended up with USD 167,23. Even worse, if you waited until the end of 2007, you ended up with 132,392. So as you can see, it is really difficult to time the market. Investing in 2000 and taking the two crises of 2000 and 2008 is still better than missing out on the growth years and investing before the crisis of 2008 and only taking one crisis.
All this data is using the growth rates concerning the MSCI World Index. Dividends (gross and net) are not included in the calculation. Anyone interested can download all historic data at MSCI.
Technology is Improving and Population is Rising
The overall point is that new technology will not necessarily replace old technology, but it will date it. By definition. Eventually, it will replace it. But it's like people who had black-and-white TVs when color came out. They eventually decided whether or not the new technology was worth the investment. –Steve Jobs
Technological development is expanding faster than ever. Moore's law describes the exponential development of the computing power. This law is still valid after centuries of chip development. The next generation of self-driving vehicles and artificial intelligence is coming and the space for growth is massive. This linked chart from Time shows that artificial intelligence will reach human intelligence by 2023 and the intelligence of all people in the world by 2045.
Furthermore, global population is increasing. Global population will be 9.8 billion in 2050, and 11.2 billion in 2100 based on projections of the United Nations. Along with the population average, wealth is increasing as well. The conclusion is easy: there will be a constant growth in the long term based on population growth and technology.
Summary
Compound interest rate and dividend growth compounding are the basic drivers for the successful return on your investment. Investing constantly is the basis for a long-term investment strategy that is independent of major market moves. Real growth is happening because of new technologies and growing global population,. Invest and keep your strategy—always look at your long-term horizon! If you want to learn more about long-term investment strategies, check the Investment Canvas.
About the Author
About the author
Jan-Patrick Cap, MBA, PhD, is a mechanical engineer working in top strategy consultancy. In his doctoral studies, he focused on innovation and network management. He worked in Europe, the USA, Brazil, China, and UAE. His passion is finance and entrepreneurship. Jan-Patrick is the co-founder of investmentcanvas.com, a website that offers a free academy and tool to learn to invest with long-term perspective.
Disclaimer: All content provided is for informational and educational purposes only and is not meant to represent trade or investment recommendations. Reliance on this content for the purpose of engaging in any investment activity may expose an individual to a significant risk of losing all of the property or other assets invested. Any person who is in doubt about the investment to which this document relates should consult an authorized person specializing in advising on investments. The author is affiliated with investmentcanvas.com.