Here’s why you need to evaluate investment performance in the context of long-term objectives – even in times of crisis
The Stanford Marshmallow Experiment is one of the more famous studies in the field of psychology. It was conducted in the early 1970s by Walter Mischel, a professor at Stanford University, and involved placing subjects – children aged 3-5 – alone in a room and presenting them with a simple choice: to eat the marshmallow in front of them right away, or hold out for 15 minutes and receive two as a reward.
As one might expect, some children quickly wolfed down the treat. But others were more inclined to wait. Follow-up studies many years later appeared to throw up an interesting insight: that the children who were able to delay gratification also enjoyed better life outcomes.
Today, Mischel’s research stands as a cautionary tale about the dangers of prioritising short over long-term thinking – and the value of keeping an eye locked firmly on the future.
The short-comings of short-termism
Short-termism is something that’s hard-wired into our DNA, we’re guilty of it all the time, in all areas of our lives. This is arguably truer of the present than at any other time in recent memory, as we refocus on our financial wellbeing, and it’s entirely understandable.
During a period of great instability, marked by unprecedented job insecurity and market volatility, it’s hard not to fixate on immediate needs, at the expense of working towards long-term goals. We need to find a way to work past our fears and overcome our biases to avoid the temptations of short-term gains, certainly in the context of our investment strategies. A short-sighted approach to wealth creation will seldom yield the best results.
In the midst of a crisis, when you’re reprioritising goals, a split second of doubt could see you crystallise a decision you otherwise would not have made, and that decision might have unintended consequences.
Why it’s important to take a step back
The last thing you want to do is cash in your investments when prices have fallen, and then try to buy back in after they’ve bounced back up. When we suffer these market shocks, or black swan-type events, we first need to take a step back and consider whether we’re speculators or investors.
So, rather than focusing on short-term fluctuations and evaluating the performance of our funds against a benchmark or index – a habit that will only encourage us to keep churning our investments – it’s more important to compare returns alongside a reformulated set of objectives.
You need to keep in mind what it is you’re trying to achieve – covering private school fees, supporting your kids through university or enjoying a comfortable retirement. Then think about how your investments are going to help you get there.
This can be easier said than done. Stock market crashes are often emotionally charged. When they do inevitably occur, people can feel compelled to react; to do something to protect themselves. We see it time and again. It’s really important to maintain distance and ask ourselves: what is it we want our money to do – and by when?
The golden rules of investing
To stay on track, we should return to the timeless, golden rules of investing. This means being in it for the long haul, with a goal or plan to guide us – and acknowledging that there will always be times when markets are more volatile.
It also means avoiding changing a long-term strategy because of a short-term correction. It’s time in the market, not timing the market that’s key. By adopting this approach and sticking with it, patient investors – who invest regularly – will be able to benefit from so-called ‘pound cost averaging’. This simply involves investing at regular intervals, resulting in more shares being purchased when prices are low and fewer shares purchased when prices are high.
Buying more units when markets are down can lead to better returns when the outlook is more bullish. Diversification is essential too, by spreading your money across multiple types of investments and geographic areas, we can potentially mitigate our exposure to risk.
The value of advice
Abiding by these rules does require discipline. Lots may be happening in the world around you and any negative news headlines will likely test you emotionally. That’s where a regular financial review can really come into its own. Using an adviser as a sounding board can help you renew your financial choices – and prevent you from making poor ones – by bringing you back to your core priorities. A Financial Advisor will remind you of the most crucial questions: what do we want to do with our money; and have our objectives or timescales for achieving those goals changed? You don’t want to take a decision for the short-term that could jeopardise your plans for a comfortable future. A good financial adviser takes a lot of that worry away.
If want to know more about how embracing the long view could improve your future prospects, just ask us.
To receive a complimentary guide covering Retirement Planning, Wealth Management or Inheritance Tax Planning, please contact Pardeep Singh Narwal of Narwal Wealth Management Ltd on 0116 242 67 77 or email email@example.com
The value of an investment will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.