Many financial experts agree that investing in stocks and shares (equities) for a sustained period is one of the keys to investing money and building long-term wealth.
‘Sustained’ refers to a significant timeframe – well beyond a few months or even a couple of years. Over time periods, shares tend to significantly outperform other asset classes such as cash and bonds.
This is the extra reward an investor can hope to receive for choosing a riskier investment. In terms of risk and reward, shares sit on a higher rung compared with, say, bonds, which in turn sit on a higher rung than cash.
One of the more challenging aspects about investing in equities, however, is that it’s nigh-on impossible to predict their price movements day-to-day with any guaranteed accuracy.
But by sticking to proven practices and demonstrating patience, there are several mainstream strategies that should prove their worth. Here’s a look at four of them.
Investing in stocks and shares involves risk and is not suitable for everyone. The value of investments can fall as well as rise and partial, or total, risk to capital is a possibility.
Buy and hold
Assemble a group of investment or wealth managers and the phrase that will ring out is that “time in the market beats timing the market”.
In other words, staying invested throughout a range of market conditions by adopting a ‘buy-and-hold’ strategy, rather than attempting to ‘time’ markets by continually moving money in and out of holdings, is usually the best course of action.
This makes extra sense for investors who are charged a fee whenever they adjust their portfolio by buying or selling stock. Trading and admin charges inevitably bite into returns, so it makes sense to avoid them where possible.
To confirm why a buy-and-hold strategy makes sense, consider the effect of having a continued presence in the market.
According to Putnam Investments, the US stock market returned 9.9% annually for those who remained fully invested over a 15-year period to 2017. But investors who dipped in and out of the market over this timeframe jeopardised their chance of enjoying such returns.
According to the company:
- investors who missed out on the 10 best trading days in that period experienced annual returns of only 5%
- the annual return dipped to 2% for those who missed the 20 best days
- missing the 30 best days produced losses of, on average, 0.4% per annum.
Choose funds over individual stocks
Seasoned investors are aware that an investing practice known as ‘diversification’ is crucial when it comes to reducing risk and, potentially, boosting returns over time.
Diversification was once described by Harry Markowitz, the Nobel Prize laureate and economist, as “the only free lunch”. It says that, if one holding within a portfolio of shares underperforms, then the overall effect won’t be to sink the whole ship.
Most retail investors channel their money into two types of investment: holding individual stocks directly or buying into collective funds.
The latter includes unit trusts and OEICs and, looking a little deeper, embraces a variety of products – from index trackers and exchange-traded funds to specialist portfolios focusing on particular regions and/or sectors (US, global, technology, for example).
To provide maximum diversification, experts recommend that investors buy funds instead of individual stocks. The thinking is that, although individual investors are free to buy a diversified array of stocks to create their own share portfolio, the process is time-consuming, requires research and expertise as well as a sizeable cash commitment to carry out successfully. A single share in some companies can cost hundreds, if not thousands, of pounds.
In contrast, funds provide retail investors with immediate exposure to hundreds or thousands of individual shares, usually for a modest outlay, with lump sum investments available from £500. Another option is for investors to channel money into funds that passively track major stock indices such as the FTSE 100 or the S&P 500. Products of this nature enable investors to buy the market return relatively cheaply – the fees on tracker funds usually cost just a fraction of a percentage point.
Reinvest dividends
Many publicly-listed companies pay their shareholders a dividend – a regular sum linked to a business’s earnings in any one year.
The amounts shareholders receive in dividends – typically equating to returns of between 3% and 4% – may seem relatively negligible, especially at the start of an investment journey. But dividends are actually responsible for a large proportion of the stock market’s historic growth.
For example, for the years between September 1921 and September 2021, the S&P 500 experienced average annual returns of 6.7%. With dividends reinvested, however, the performance jumps to nearly 11%. That’s because each reinvested dividend helps to buy more shares which in turn help boost the return on the overall investment.
Many financial advisors recommend that long-term investors reinvest their dividends rather than receiving the payments as cash. Most trading platforms provide customers with the option to reinvest dividends automatically.
Choose the right investment account
Investment choices are undeniably important to long-term investing success. But regardless of whether a portfolio is tilted towards either funds or stocks, another crucial decision relates to the nature of the investment account where the holdings are kept.
For example, individual savings accounts (ISAs) are tax-efficient wrappers that savers and investors can use each tax year to shelter a certain amount – known as the ISA allowance and currently worth £20,000 – from income tax, dividends tax and capital gains tax.
The bottom line
To make money from equities, there’s no obligation for investors to spend days speculating on which individual company shares will go up or down.
Even the most successful investors, such as Berkshire Hathaway’s Warren Buffet, recommend that people invest in low-cost index funds and hold on to them for years or decades until they need their money.
In many cases, investors simply need enough patience so that a diversified basket of investments can pay off over the long term. This is in stark contrast with the need to chase the latest investing trend or hot stock.
