Recently, I read the Schroder’s Global Investor Study titled “Are millennial investors facing a perfect storm?” which analyzed the expectations of investors, and in particular, millennial investors. I thought that some of the millennials’ expectations were extremely unrealistic and out of touch with reality. Unfortunately, having the wrong expectations when it comes to your investment returns and time horizons can seriously hurt you down the line. Although you won’t feel the effects until later in life, and often when it is too late, it is important to start planning correctly now since the impact of the decisions you make now will be magnified in the future.
What Were These Expectations?
The two most dangerous expectations I saw were in terms of expected return and investment time frame. Millennials expected a 10.2% annual return on their investment. Although 10.2% is achievable, it is certainly above historical average and would require a high level of investing intelligence. Sure, Warren Buffett was able to achieve 20%-30% for many years, but most people don’t have the time to really sit down and study the art of investing. People have jobs to go to, families to raise, and social events to attend. Instead, millennials should expect an average annual return of 7%-8% through the use of low-cost, diversified exchange-traded funds. That range is more within historical averages and most likely still achievable going forward, assuming you hold your money in the market for the long run. Even though 7%-8% may not seem like a high return, over a long time horizon such as ten or twenty years, it can be substantial.
Equally important, the study found that 63% of millennials hold their investments for less than two years. Two years is an extremely short, and possibly dangerous time frame for an investment. I know that we live in an age of instant gratification. We have smart phones that allow us to Google information instantly. We have services such as Netflix that allows us to watch shows on demand. Technology has changed our expectations on the speed of life and eroded our patience and ability to wait things out. Unfortunately, investments haven’t changed in that regard. Investments still take the same amount of time to grow and compound as in the past. Instead of two years, we should be holding on to our investments for at least five years. If we are investing in strong dividend payers, I think we should hold on to them for life while reinvesting and growing the dividends. The dividends can be our source of income and not require us to sell any of our stock. Regardless of what we invest in, we need to extend our time horizons to over five years.
Why Extend Time Horizons?
I had previously written about why it was important to start investing early. I will illustrate that again today. Take a look at the table below which shows four different scenarios.
If you started investing $5,000 per year at the age of 22, you’ll be better off than if you started investing $10,000 a year at age 31, by the time you retire at 65. By postponing investing by nine years, even putting in $130,000 more in the market does not make up for all the lost years of compounding. In fact, if you started investing at age 39 (17 years after age 22), you’ll need to contribute $266,000 more into the market to come out similarly well off.
Here’s a simpler example. If you save and invest $4,000 every year for 40 years, assuming an 8% average annual return, you’ll be a millionaire. Can you figure out a way to save $4,000 every year? Are there places where you can cut expenses? If you have a decent job and make smart financial decisions, it should be within reach to scrape aside that much money in a year. That’s approximately $333 per month. Perhaps you can hold off on that new car lease or live in a cheaper place. On the other hand, maybe you can find a part-time job or work more hours to make some additional money.
The key message here is that most people do not understand the huge impact that time has on your investments. Additional time will more than compensate for lower returns. Therefore, aim to keep your investments in the market as long as possible. You need to keep your investments in the market without selling in order to take advantage of compounding returns while riding out all the years of negative returns. Furthermore, keeping your investments in the market will also minimize your transaction expenses and tax implications. I’m not saying that you should never sell. If you are invested in an individual stock and the company has fundamentally changed for the worse, then you may need to sell. If you seriously need money for an emergency, then you may need to sell. If you need money to make a downpayment on a house, then you may need to sell. With a few exceptions, you should hold on to your investments for as long as possible.
How to Learn Patience
So how exactly do we develop more patience when it comes to investing and in life in general? I have detailed a few ways to cultivate more patience in your life.
Meditation is a way to stop your thoughts and help you calm down. Just ten or fifteen minutes a day will allow your mind to calm down and take a step back to look at the big picture. It will help you slow down and enjoy the present moment. Compulsive thoughts such as “do I need to sell right away to lock in my gains”, “I really want to buy that new car”, or “the market crashed today so I need to sell” will slowly wash away. You’ll be left in a state of calm and peace, which will help you make a better investment decision with more mental clarity. The best investment decision in most cases is just to do nothing.
Try to avoid being mentally and emotionally “attached” to your portfolio, stock returns, and money. Your wealth is not YOU, it is just something that you own. Have the mindset that it can flow in and out, but in no way defines who you are as an individual. Ignore the day-to-day returns and realize that it is natural for your wealth to fluctuate. If negative emotions arise when your investments do poorly, acknowledge those emotions, feel them, then let them dissolve before taking any action. The worst state to be in is when each little move in the market elicits a strong and irrational reaction. Thankfully, that extra moment you wait and allow your emotions to pass before making a decision can save you a lot of money in the future. When the market crashes, you won’t make a rash decision to sell when you should buy more.
Don’t Compare Yourself to Others
There will always be people who make more money than you, have better returns than you, and have larger portfolios than you. Don’t compare yourselves to them since that is a losing game. Just focus on what you can do and look to people who perform better than you as inspiration. If you can avoid comparing your wealth to others, you won’t feel as much of an urge to make poor, rash decisions that will hurt you financially.
Hopefully I have convinced people of my generation to hold onto their investments for a longer period of time and to have more reasonable expectations regarding their investment returns. I think that cultivating patience with the techniques I have provided will be very helpful. Have you had to readjust your expectations regarding your portfolio and returns at any point?
Professional Development and Personal Finance Blog