INSIGHTS

Time is one of your best friends when it comes to investing in equity markets. It helps to smooth out periods of volatility and allows the benefit of compounding to accumulate.

A week or even a year is a very short period when it comes to many things in life, including investing. And just like our everyday lives, which can be interrupted by unexpected events, so too can the performance of companies and the broader share market.

Covid was a clear example of this. It had an unprecedent impact on our lives, just as it did on businesses, supply chains and the global economy. It also highlights why, when investing in shares, a long-term investment horizon (10 years plus) is required.

In the short term, we can often see dislocations between a company’s fundamentals and its share price performance. This has been more evident in recent years as investor sentiment has swung materially with the rapidly changing investment backdrop (Russia/geopolitical issues, Covid, inflation, and now recession fears). These factors can see sharp short term share price movements as investors try to digest the impacts on sectors and companies.

However, over time investor focus reverts to the core fundamentals of a company. Time also allows for the fluctuation we can see in share prices over shorter holding periods (both on the upside and downside) to smooth out, resulting in less volatile returns for investors.

Time allows for fluctuations in share prices to smooth out

Over short periods, share prices and equity markets can be extremely volatile. Using the US market as an example, we have plotted the annum return over rolling 12-month periods since 1976. Alongside this, we have graphed the annual return of the US market over rolling 10-year periods.

Source: Refinitiv, Craigs Investment Partners

It is clear to see the benefit time plays in reducing volatility and smoothing returns when it comes to investing. While the average return from US equities since 1967 has been 7.1% per annum, the volatility of these returns over rolling 12-month periods has ranged from +53.7% to -44.8% (in US dollar terms). This compares with an average annual return of between +16.8% and -5.1% when looking at returns over a longer holding period (in this case 10 years).

While it is safe to say we would all be very happy to see markets (and our portfolio) rise by 53.7% a year, sharp rallies such as this typically follow periods of weakness in markets. In this instance, the rally came of the back of a 33.9% decline in equity markets, over a one-month period, as the world reacted to the outbreak of Covid.

Despite this volatility, looking at returns over the 36-month period since reaching its pre-Covid highs, the US market has risen on average by 5.0% per annum. While this is below the 7.1% average return achieved by the broader US market since 1967, history has shown that given time returns have tended to converge towards their long-run average and even those that found they had invested at the peak in markets have seen the value of their investments recover.