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Many people tend to look at long-term investing as something that they would want to consider or action ‘one day’, but seldom do they realise that the first step to a long-term strategy can be taken today.
A new movement called the Financial Independence, Retire Early (FIRE) movement is well underway, picking up momentum as more and more people realise the value of long-term investing and the value of taking charge of their own financial futures. One of the challenges, however, is being able to make the right choices that could not only grow your nest egg over time but also ensure you don’t pay too much in management fees while doing so.
The idea behind long-term investments
The value of investing over the long-term is often underestimated, as investors try to take advantage of short-term fluctuations in sharemarkets. As has been proven time and again, the market often rewards those who have the ability and confidence to hold on. Financial markets generally follow economic growth cycles of boom and bust where a cycle could last for anywhere from between 2 to 5 years.
However, in the long run, financial markets have historically shown a tendency to make gains, as markets have tended to display growth when seen over a span of 15 to 20 years. For example, the period from 1991-end 2016 saw the Australian economy enjoy its longest period of growth over the past 50 years with an average growth rate of 3.2% p.a. This long-term perspective allows cycles of boom and bust to even out and, if history is a guide, the potential for a positive trend over time – which the savvy investor can seek to capitalise on.
The power of long-term investments
Naturally, there are rises and falls in the market every day, every month and every year, but by being focused on the goal of retiring early and having the patience to hold on for the long-term, those with a distant investment horizon should have a better chance of meeting their objectives and having their investment grow, despite any short-term fluctuations.
Let’s consider an example where an investor is able to invest $1,000 every month, adding up to a total of $12,000 every year, into long-term financial investments such as a low-cost, broad market ETF. If the broad market that the ETF aims to track grows at a rate of 4% annually over a period of 25 years, at the end of 25 years, that investment could be worth a handsome sum of over $500,000, minus any fees or expenses.
If an investor can afford a higher investment amount, the returns could be much higher, and they may even be able to make it to retirement even faster.
Investments for the long run
Some people fail to realise the value of long-term investments since they are caught up in the rough and tumble of sharemarkets, looking for short-term gains instead of focusing their energy and money on the long-term. But what are your options for the long-term?
Not everyone has the propensity to swim in the rough seas of the sharemarket. There are all kinds of turbulence and disturbances that you may have to deal with, and it takes energy and focus to stay on top of the game. That’s why people started investing in traditional, unlisted managed funds.
While these managed funds do a good job in diversifying a portfolio and managing risks, in general, the major drawbacks of these investments are the costs. Such funds are typically actively managed and, naturally, can come with high fees due to the resources dedicated to making active investment decisions, which can eat into whatever gains are realised through the long-term investment strategy.
Low-cost investments for the long run
One of the few things that an investor can control are the costs of investing. This is why, for an investor with a long term horizon, an investment in a low-cost fund focused on a diversified portfolio of shares can make sense.
ETFs or Exchange Traded Funds are known for their simplicity and diversification, as well as their ability to keep costs low. Such low costs, coupled with their passive investment methodology, means that over the long-term their performance should closely follow whichever underlying index they are designed to track.
Planning for an early retirement
The best time to start a long journey is now, since every passing day shortens the time available for long-term benefits to materialise. Having a long-term focus allows you to ride out short-term fluctuations, while seeking positive returns that compound with time.
While individual investors may not have the knack to manage the ebbs and flows of the sharemarket themselves, and while unlisted managed funds can be expensive on account of their associated high management fees, you could get the best of both worlds by investing with a long-term focus using professionally managed, exchange-traded funds that are low on management costs.
BetaShares’ Australia 200 ETF (A200) is now the lowest cost Australian shares ETF available on the ASX with only 0.07% p.a. management costs. It also offers the advantage of being simple to access, diversification, transparency and quarterly distributions from dividend income.
Of course, an investment in A200 is still an investment in shares, which means you should be comfortable with a higher level of risk than an investment in cash or bonds and realise that your investment can go down in value, as well as up. Also, an investment that gives share exposure should be considered as a component of a diversified, overall portfolio that might include allocations to other asset classes, considering your particular circumstances, including your objectives and tolerance for risk.
ETFs may fit the bill for low-cost, long-term investments. And if you are able to allocate a steady amount of your savings to long-term investments, you may not be too far away from realising your dream of FIRE.