Financial columnists always talk about how investments perform in the long term. For example, over many decades, stocks tend to outperform bonds. However, I wonder if we’ve reached the stage in world events when we can no longer confidently count on there being a long term. Wars, continuing climate catastrophes, pandemics and the like might well bring down economies for a very long time. Or, in the worst possible case, in which several disasters occur simultaneously, there might not be a long term at all. Is it time for the investment world to stop talking about the long term as if it were a sure thing?
First, thank you for the cheerful message.
Kidding aside, I think most people would agree that the world is facing some serious, even unprecedented, challenges. I could add a few other items to your doomsday list, such as growing income inequality, housing unaffordability, food insecurity, cybercrime, artificial intelligence, rampant disinformation, political radicalization and growing authoritarianism around the world.
But before we get too depressed, let’s back up for a moment and explore why financial pundits recommend focusing on the long term. There are a few reasons.
One is that investments – equities in particular – are highly unpredictable in the short run. Stock prices are buffeted on a daily basis by economic data, interest rates, currency fluctuations, geopolitical events and shifting investor sentiment. These factors are reflected in the little jagged lines you see on a short-term stock chart.
But if you zoom out and look at a stock chart over many years or decades, those little (and sometimes not so little) ups and downs recede into the background and the stock’s long-term trend comes into focus. Typically, a company with rising sales and earnings will slope up and to the right as the market recognizes its true value. On the other hand, a stock that rises largely on hype, without the fundamentals to support it, will eventually fall.
The legendary value investor Benjamin Graham perhaps summed it up best: “In the short run, the market is a voting machine, but in the long run it is a weighing machine.” (There is some debate as to whether Mr. Graham actually uttered those exact words, but he certainly subscribed to their meaning.)
A second reason people are told to invest for the long term has to do with compound growth. The best way to illustrate this is with a simple example. Say you put $1,000 into a compound interest savings account that pays 5 per cent annually. In the first year, you’ll collect $50 of interest and finish with $1,050. In the second year, you’ll make $52.50 of interest and have $1,102.50. The rate of growth remains the same – 5 per cent – but the dollar value of your investment rises by an increasing amount each year. By year 20, your investment will grow by about $126 and you will end up with about $2,653.
Thanks to exponential growth, the longer you hold a compounding investment, the larger the dollar gains will be each successive year (all else being equal). This is why reinvesting dividends (or interest) is so important to generating long-term wealth.
A third reason to focus on the long run is to prevent you from doing something you might later regret. Every company has setbacks, and with interest rates rising sharply in the past couple of years, there is no shortage of stocks that have been crushed. Focusing on the long-term prospects of a company, instead of worrying about the short-term performance of its share price, helps to control one’s emotions.
Now, back to your question: What if there is no long term?
Well, if the world is going to end soon, there’s no point in buying stocks or locking your money into a five-year guaranteed investment certificate. By the time the GIC matures, Earth will be a giant, smouldering mess. If you think your discount broker puts you on hold for a long time now, just wait.
On the other hand, if you think there’s even small a chance the world might squeak through, you’ll need to invest as if you – and the planet – will be here for a long time.
It’s not such a wacky assumption. Financial markets – and civilization itself – have survived countless threats before, from Cold War nuclear standoffs to various plagues and pandemics. Just since the turn of the century, we’ve endured the dot-com bust, 9/11 attacks, countless wars, the U.S. real estate collapse, a global financial crisis that bankrupted dozens of investment banks and mortgage lenders and, last but not least, the COVID-19 pandemic that led to massive dislocations in the global economy.
It’s been a pretty rough couple of decades. But care to guess how financial markets performed during that period? Well, from Dec. 31, 1999, through Nov. 1, 2023, an investment in the 60 largest stocks of the S&P/TSX Composite Index would have more than quadrupled, assuming all dividends were reinvested. The S&P 500 nearly quintupled on a total return basis over the same period. Only by looking at the long term can you put the world’s current struggles into perspective.
For all the horrors that humans perpetrate on one another, and for all the reckless financial and environmental decisions people make in the pursuit of wealth and power, history has shown that something resembling sanity ultimately prevails. One has to hope that will be the case again, and make investment decisions accordingly.
That’s not to say you should throw caution to the wind and put all of your money into stocks. As always, a well-diversified portfolio that includes allocations to equities, fixed-income and cash will help to control your risk, and your emotions, during these turbulent times.
That way, if there is a long term – as I suspect there will be – you’ll be prepared.
E-mail your questions to firstname.lastname@example.org. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.