22 May 2024
In the world of investment, the most valuable assets are often those right in front of you. One such asset, frequently overlooked, is time. At first glance, this might seem like an odd statement. However, upon closer examination, the value and power of time become evident. So, stay with us, and we will explain precisely what we mean.
In a strange turn, as people, the value of time becomes greater as we grow older, and we approach the twilight years. In investment terms, the longer the duration the more value this is to both investment returns and, to generalise, pressure and mental health.
Even before we delve into the main ways time can significantly impact your investment returns, it's essential to recognise that we already pay a premium for time in the markets. For instance, long-dated options include a time premium, and extending the settlement date on a stock purchase usually incurs additional charges. These fees aren't penalties but rather the cost of securing more time.
Since time is already a tradable commodity, let's explore how it can influence your investment returns and strategy.
First, consider the impact of compound returns and the role of time in this process. Here’s an example:
· Investment pot: £1 million
· Average annual return: 10%
If you withdraw the 10% return each year for living expenses, you would take out £500,000 over five years, leaving your investment pot at £1 million. However, if you reinvest the returns over five years, your £1 million would grow to £1,610,510. This is £110,510 more than the scenario where you withdrew the returns annually, equating to an additional 7.36% return due to compound returns.
Time can also alleviate financial pressure, especially for those with ambitious long-term financial goals. Consider a £1 million investment pot with a target of £2 million:
· 10-year timeframe: Requires an average annual compound return of 7.2%
· 5-year timeframe: Requires an average annual compound return of 14.9%
While both scenarios demand finding suitable investments, the longer duration allows for a more structured approach and reduces the impact of market volatility. This extended timeframe also offers greater flexibility and lessens the immediate pressure to achieve high returns quickly.
Conversely, if your target was 14.9% a year and you had a bad year, let's say your investments fell by 5%, this would have a disproportionate effect on the returns required going forward and put even more pressure on you to find the right investments.
Time significantly influences your attitude to risk, particularly in the context of pension strategies. Starting a pension at age 25 and planning to retire at 65 gives you 40 years to invest. This long horizon encourages a focus on growth stocks initially, a balanced portfolio in midlife, and a shift to more liquid assets closer to retirement.
On the flip side, starting a pension at age 45 leaves only 20 years until retirement. The shorter period makes high-growth, high-risk stocks less attractive due to their volatility, necessitating a quicker transition to safer, more liquid assets. A longer investment period also increases the likelihood of recovering from poor-performing investments early on.
Given the extended life expectancy in the UK and the rising cost of living, safer retirement investments become even more crucial.
These cold, hard facts and figures vividly illustrate the impact of time on investment returns and strategies. While longer timeframes can mitigate financial pressure and influence attitudes to risk, the most significant benefit is the effect of compound returns. Regular, long-term investments, such as pensions, have the potential to deliver impressive returns over the long run.
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