Save, make, understand money


BLOG: The importance of a diversified and long-term investment strategy

Paloma Kubiak
Written By:
Paloma Kubiak

Today’s investors are currently facing mounting uncertainty due to geopolitical conflict, inflation levels at a point not seen for decades, and rising interest rates around the globe. The importance of building a diversified portfolio to help for the long-term, has perhaps never been more important.

Arguably, one of the most important things about being an equity investor is being invested for long enough to weather short-term volatility. Investors are often at the mercy of their emotions, and the impulse to invest when things look good and sell when things look bad can be overwhelming, but it is nearly impossible to achieve perfect market timing.

Ultimately, phasing investments helps avoid agonising over when is the ideal moment to invest or sell, and it is important to bear in mind that the best investment opportunities are often found when the outlook appears bleak.

Staying invested in equities over longer periods increases the likelihood of positive returns. The more time your money stays invested, the greater the opportunity for compounding and growth.

With the current economic climate, it is understandable that many investors are spooked and opt to sell their investments. However, history has demonstrated time and time again that while markets can have a bad day, week, month or even year, investors are less likely to suffer losses over longer periods.

This chart, which shows the number of loss-making periods endured by a broad US equity market index (as a percentage of the total number of periods), illustrates the concept:

Source: Bloomberg 13/06/22

Looking at the S&P500 returns since 1972, over all one-year rolling periods an investor would have obtained a positive return 80% of the time. Over a five-year rolling period this percentage increases to 90% of the time. Over longer periods, losses become increasingly rare so that in all periods over 12 years, there were no losses incurred.

Not only does the data show a clear trend that the probability of losses in an equity investment drop off significantly over five years, but the magnitude of any losses also declines over time.

Not only is it important to have a long-term investment strategy, but it is also wise to hold a diversified portfolio to future-proof your investments. During uncertain times, diversification is more important than ever. This means spreading portfolios across a wide range of companies, but also geographies and investment manager style, so that if one area performs poorly, another may make up for it.

While volatility and uncertainty may be high in difficult times, long-term investors can still benefit from owning shares in well-managed companies with sustainable earnings.

The last few years has seen an increase in equity market volatility with some marked rotations between investment styles reinforcing the importance of diversifying exposure across different managers.

Data from Morningstar highlights the benefits of having a multi-manager approach. Again, taking the US market as an example, in the twelve-month period to 30 June 2022 (a difficult year for equities) if an investor had chosen the best investment style (large value companies) they would have broken even, but an investor in small growth companies would have lost 36%.

Furthermore, even if you look at the difference in investment styles over five years, the difference between returns of the worst performing investment style (small cap core equity) compared to the best (large cap growth equity) was 8% per annum.

So, if you invested £10,000 five years ago in the worst performing style you would now have £12,500, in comparison to over £18,000 if you’d invested in the best performing investment style – a significant difference in returns over a relatively short period.

These figures show the advantage of opting for a fund that can choose a range of different managers that have different investment styles.

Ultimately, markets can be volatile and even negative in any given day, week, month or year. But history shows that both time and diversification can go a long way toward protecting investments in times of market instability and resulting in strong returns.

James Hart is investment director at Witan Investment Trust