When it comes to investing, time is central to all decisions. No matter what your investment goals are, the longer you can save for, the better.
Albert Einstein speculated that time was the fourth dimension, adding it to the conventional three in his theory of relativity. Yet in investment, time is the only dimension that matters. Fortunately, the concept of time in investing is far simpler than in physics. Generally speaking, time is the investor’s friend. The longer you save, the more money you accumulate. But time also tends to magnify the power of investing through compound interest.
Here Einstein is once again able to provide an interesting perspective. According to financial legend, he may have once quipped:
Compound interest is the eighth wonder of the world. He who understands it earns it; he who doesn’t pays it.
Regardless of whether Einstein actually said these words or not, the point is still an interesting one: interest paid one year itself then attracts interest the following year. That makes the effect of a 5 per cent interest payment paid every year for 20 years powerful – USD 1,000 would become USD 2,712.64. The power of compounding applies not just to bank interest payments but also to the coupon on a bond and the dividend on an equity. Those who can capitalise on compound interest are therefore able to benefit greatly.
The effect of compounding interest over a long-time horizon is therefore very significant for a portfolio. It’s hardly surprising, then, that when asked for the one piece of advice that investors should take to heart, Julius Baer’s Chief Investment Officer, Yves Bonzon, said: “My best advice is to take a long-term approach, steadily save, and gradually increase the amount you invest. Additionally, investors should be as agnostic and calm about short-term market- to-market valuation fluctuations as possible.”
As well as influencing your investment horizon, time also influences the assets you choose to invest in. When one is saving for a long period of time, such as 20 years, conventional wisdom dictates that one should invest in higher-return, higher-risk assets – for example Asian equities. Then one should gradually de-risk the asset portfolio later, perhaps by investing more in bonds.
To understand the logic of this, think of the stock market’s gyrations in the 2007-09 financial crisis. The MSCI Asia ex Japan index fell by 52.38 per cent in 2008 (in US dollar terms) – before bouncing back the following year, rising by 72.08 per cent. Someone due to retire early in 2009 with all their assets in Asian equities would have had to adjust to a more austere existence than someone with a more diversified, lower-risk portfolio.
Of course, some investors seek to use volatility such as this to their advantage, selling the peaks and buying the troughs. Indeed, this is when a good wealth manager can add real value; generally only experienced traders with keen insights into securities’ trading patterns, the relevant news flows, and the rhythms of the market succeed in market timing.
For those wanting to be more self-directed, though, investing on a regular basis – for example saving monthly – can help you to avoid the hazard of market timing. After all, even Warren Buffett, the fabled investor and chairman of US conglomerate Berkshire Hathaway, steers clear of seeking to time equity market investments. Judging whether prices are about to rise or fall is too difficult, he says.
Most recently, Buffett wrote in the company’s 2018 annual shareholders’ letter: “Charlie [Munger, Vice Chairman] and I have no idea as to how stocks will behave next week or next year. Predictions of that sort have never been a part of our activities. Our thinking rather is focused on whether a portion of an attractive business is worth more than its market price.”
One thing that is certain in finance is that we cannot predict the future. That is why, when it comes to securing financial wellbeing, taking advantage of the time available is key. By starting to invest and save as early as possible, and combining a long investment horizon with the power of compounding, investors should be able to optimise their portfolios for the future.
How to invest
Financial subjects can be complex in nature. Our ’How to Invest’ series aims at explaining them - one step at a time.