4 Simple Ways to Invest for The Long Term

Most people do not want investing to take up too much of their time and effort. This is due to us having many other things in life to focus on, such as our careers, families, housing etc. And so, trading, timing the market and stock picking is not suitable for 90% of retail investors.

So how can you grow your money without taking up too much time and effort? Here are 4 simple ways to do so and if you stick to this, there will be a high chance for you to retire comfortably after 20 to 30 years.

1) Start Early & Stay Invested

Inexperienced investors looking to grow their money without active monitoring can first look to compound interest to pursue gains over time. The key ingredients here are starting early, and staying invested. By doing so, you will have more time to grow your money. The table below shows how even saving and investing a small amount every month when you are young benefits you, simply because of the power of compound interest.

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2) Diversify Your Portfolio Among Various Assets and Geographical Regions

Market timing and stock picking are not suitable strategies when you want to invest passively. What you can do is to construct a well-diversified portfolio.

Diversification involves another important concept – Asset Allocation. This means mixing you portfolio among various asset classes to spread your risk. The most common asset classes for retail investors are: equities, bonds and cash. A lack of diversity means less liquidity in times of need.

A simple two-asset portfolio, comprising bonds and equities, helps to enhance returns and reduce risk. The proportion of a person’s investment portfolio to be allocated in bonds should be equal to the person’s age (or age minus 10 if he/she is more risk tolerant).

The reason behind this formula is because as we age, we are closer to retirement and should safeguard out nest egg by having less exposure to risky assets such as equities. For young people who mostly have higher risk tolerance, they can allocate more of their investments in equities which can potentially yield higher returns. I have written a separate article on why we should invest in equities if we have a long investment horizon to prepare for retirement.

Besides the classes of assets, having a basket of stocks spread across different geographical regions can reduce your long-term portfolio risk.

Interestingly, we should note that much research have shown that more than 90% of investment returns are determined by asset allocation. Only 10% is influenced by stock picking and market timing. The pie chart below illustrates the recommended asset allocation for a person with a moderately aggressive risk profile.

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3) Invest Regularly – Effect of Dollar Cost Averaging

Every stock investor may fall into the trap of emotional or irrational investing. This stems from our 2 strongest emotional forces – fear and greed, which leads to failure to grow our money.

1. Fear – When the price of our stock holdings fall, a common response stemming from fear is to sell our shares and cut our losses. Subsequently, when the stock price rises, we may be afraid to invest in the stock again. If the stock price continues to rise, we may enter the market too late to see any substantial return.

2. Greed – When we see the price of a stock going up, greed drives us to invest our money in it, with irrational optimism that the price will continue to rise. Quite often, the stock price drops instead.

Emotional/irrational investing often yields little returns for retail investors. Instead of speculating on a stock price, we should do quite the exact opposite – We should set aside a fixed amount of money to invest regularly, regardless of how the stock market is performing. The graph below illustrates what happens if we invest a fixed sum of money on a monthly basis for a certain stock, X:

DCA graph

This enables us to take advantage of Dollar Cost Averaging, a passive mechanism which helps you to buy less of an investment when the price rises, and more when the price falls. This lowers your overall purchase price for investments in the long term.

4) Review and Rebalance Your Portfolio

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Given the dynamic global economy, investors should review their investment portfolio regularly and change the mix of assets, a process called rebalancing. Rebalancing safeguards your portfolio from being exposed to undesirable risks and maintains your original desired asset allocation. This would ensure you are on track to meeting your financial goals.

How is “Safe” Actually Dangerous? And Vice Versa…

Some people may feel that investing in equity markets is dangerous. This is true when you do it for the short term and focus on a single country market. However, if you have a globally diversified portfolio and are able to invest for the long term, you will be able to enhance your returns with a low level of risk.

Here’s a simple question – Do you think the world’s economy will be larger 20 years from now than it is today? More likely than not, the answer is yes. The world’s population will be larger in 20 years, which will lead to more people using/wanting goods and services provided by companies. With an increase in overall demand, companies will be producing more and generating more profits. With greater profits, stock prices and stock markets will rise. The MSCI World stock market index shown below reflects how our economy grows with time.

Credit: Wikipedia
Credit: Wikipedia

Population growth is not the only driver. Human beings are also always demanding a better standard of living. For example in Singapore, we “upgrade” from a HDB flat to a condominium; we drive a small car and “upgrade” to a larger one. As markets like China, Thailand and even Vietnam open up and grow economically, their people will have higher incomes. They will start with demanding basic consumer goods and as their incomes grow, they will want to buy more and better products.

You may ask – If I put all my money in Thailand today, can I expect a definite profit in 20 years’ time? That is harder to predict although there are many good reasons to believe that Thailand will continue to grow. Many countries have faced extended periods of decline before (e.g. Japan in the 1990s). This is why you need to have a well-diversified portfolio across different regions and countries around the globe.

Our annual inflation rates in Singapore for the past 3 years have been fluctuating from 1.5% to 5.4%. This is precisely why it is risky to leave your money in “safer” instruments such as fixed deposits (often yields below 2% annually), because it might be worth less than the amount you would have to pay for your daily needs over time.

Everyone should know the difference between gambling and investing. A trip to casino can be fun but approach stock market in the same way and you will find yourself in trouble. Like a turbulent flight, volatility is uncomfortable and it is easy for anyone to bail out at the first wobble. However, if you are currently in your 20s or 30s, youth is the single huge advantage for you to ride out the ups and downs in the long term. Successful investing requires one to embrace volatility, not fear it.

But if you keep your money in fixed deposits or other “safe” instruments, you do not know if the returns will keep pace with inflation over the long term and that will be a real danger.