Investing well is important. However, investing well over long periods of time is most important.
Everyone would agree that making a one-time 50% return on an investment is a wonderful outcome. But making a 7% return each year for 40 years is a far better outcome, as it multiplies your initial investment by a factor of 15!
This is an important principal to remind ourselves of, especially at the moment when our lives (and, to some extent, markets) have been turned upside-down by Covid-19!
Even moderate returns over long periods generate massive wealth
The chart below published by Vanguard (click to enlarge) calculates how much $10,000 invested in 1990 would be worth today.
The Australian (ASX200) index is currently trading at 5,985. If it grows at 2% p.a., what will its value be in 50 years’ time?
The answer: The ASX200 would be 16,100.
If it grew by an average of 4% p.a., it would be worth 42,500. Now, imagine it if grows by 8% p.a. – which is still below the 8.9% p.a. growth rate over the past 30 years. That would push the ASX200 index above 280,000!!
This simple example illustrates the beauty of playing the long game.
But to successfully play the long game, you must resist the temptation to get sucked into the incessant short term ‘noise’, worry and predictions.
I am usually sceptical when people tell me things have changed forever
The world is full of forecasts. At the moment, many commentators are telling us that the work-from-home (WFH) movement will result in companies deserting commercial office space en masse. And increased WFH will also result in a permanent increase in demand for regional property – since we don’t need to travel into the CBD anymore.
As Mr Buffett says, “forecasters will fill your ears but never your pockets”. You should be sceptical when anyone tells you that things have changed permanently overnight, because they rarely do.
Let me use WFH as an example
It is my view that WFH will have some impact on demand for commercial office space and, to a lesser extent, residential property in regional locations. But the size of its impact has been grossly overstated.
The forced increase in WFH (thanks to Covid-19) has certainly increased its acceptance. I suspect in the past many people thought WFH was used by people as an opportunity to ‘hide’ and reduce their workload. However, now everyone knows WFH means you work just as hard as you do when you’re in the office – often harder, as there’s fewer distractions.
Some CEO’s have also mentioned to me that that they used to feel obligated to be “seen” in the office each day, but this expectation has now changed.
However, just because you have successfully WFH for the past 6 months does not mean you will be able to do it for the next 6 years.
The reality is that permanent WFH does not suit the majority of industries, employees and employers. Most of us will still need an office to retreat to. Therefore, I think the likely long-term outcome is that more people will spread their time between the office and home. The ‘office’ is not dead, and neither is WFH – see here for more comments.
How to derive stable and attractive returns from property over the long term
In order to persistently achieve a capital growth rate of approximately 5% p.a. above inflation, you must invest in a location that has robust fundamentals. These fundamentals will ensure that demand will consistently exceed supply over long periods of time. And that translates to capital growth.
In most developed economies around the world, income and wealth inequality is getting worse. The rich are getting richer, and the poor are getting poorer. According to the ABS, the wealthiest 20% of Australians own 63% of private wealth. Whereas the lowest 20% own a mere 1% of private wealth.
Of course, most of us would agree that this concentration of wealth is unfair, and governments must implement bipartisan policies to improve equality. However, this trend has been getting worse since the 1970’s (as cited in this US study). Frankly, I don’t anticipate it abating anytime soon. Capitalism seems to be an unstoppable force.
The reality is that the supply of houses (land) in blue-chip suburbs is finite. However, our population is growing at a much faster rate than other developed economies (i.e. 2.5 to 3 times faster than the UK and USA, for example). As such, it is not difficult to see why there is a growing cohort of people wanting to buy into Melbourne’s blue-chip suburb, Hawthorn (for example). And these people seem to have the endless ability to “pay more” than the last person, partially due to the distribution of wealth. Most of the wealthiest 20% want to live in inner-city suburbs that occupy less than 20% of the capital city (in land size).
Playing the long game with property means you must invest in a location that is supported by the laws of supply and demand. It’s not about investing off the back of short-term trends or fads.
How does this apply to investing in shares?
Australian listed company Afterpay is often cited as a stellar stock – rising from $9 per share in March 2020, to over $90 a few weeks ago (it’s since retreated to $75). No one is going to be disappointed with earning a 10-fold return.
However, there’s a few problems with investing in Afterpay. Firstly, your success is dependent upon knowing when to sell, as the company doesn’t make a profit, burns through cash and will soon attract substantial government regulation and increased competition. So, its share price is a fragile house of cards, with no foundation. As Kenny Rogers said, “you’ve got to know when to fold ‘em”.
If you successfully make money from investing in Afterpay, what do you do next? You’ll have to pick the next winner – and keep doing that consistently well for years on end. Good luck.
Alternatively, you could adopt an investment methodology that avoids the risk of picking the wrong stocks, sectors or investment managers.
Adopting the lowest risk methodology is the best way to achieve the most predictable and consistent returns in the long run. Much like those that are illustrated in Vanguard’s chart above.
And finally, applying it to cash flow
The difference between saving $100,000 once every 10 years or $10,000 consistently each year is substantial.
The ability to predictably and reliably contribute a regular amount towards an investment strategy will be substantively more effectual. For example, it will allow you to spread your timing risk, adopt a gearing strategy and so on.
By the way, jump to the 26-minute mark in this video for a description of a banking structure that allows you proactively manage your cash flow, eliminate unconscious expenditure without needing to track every dollar and cent.
Focus on both: the quantum AND length of the return
Getting distracted by shiny objects is an easy investment mistake to make, especially when markets feel volatile and unpredictable.
But it is times like these that we must remind ourselves about the fundamentals of investing.
Adopting an investment approach that generates attractive and consistent returns over the long run has always been the most successful approach.