Profit from patience

Successful investors share a secret: they know that one ingredient, above all, will give them the best possible chance of maximising their returns over the long term. It’s all about showing patience.

You might even call it the ‘do nothing’ mentality – by doing nothing you could increase your chances of long-term growth. “Over a one-year period, the general stock market is up 75% of the time,” explains Chartered Financial Planner Sam Sloma. “Over a five-year period, it’s around 88% positive. Over 10 years, it goes up to 94%. And there has never been a rolling 20-year period where you haven’t had [positive] returns.”

The crucial point here is that in the past at least, the stock market has been a fantastic vehicle for long-term wealth creation – it has enabled people to save and invest to meet their goals and ambitions. In the short term, however, the stock market can be volatile; the fortunes of individual companies and economies can wax and wane – share prices can rise and fall accordingly.

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The danger is that impatient investors focus too much on this short-term volatility. They get spooked when share prices fall and pull their money out of the market. Or they think they’ve spotted an opportunity and put money in to chase a profit. These are natural human instincts, but they can prove damaging to your wealth.

The cost of impatience

That warning is underlined by modelling done by Alliance Trust. It compared the theoretical fortunes of two investors who both put £10,000 into the investment trust 30 years ago and subsequently added £100 a month to their starting capital. One investor left the money completely untouched for three decades; the other sold 25% of their investment each time the market fell 5% or more in a single day, buying back into the fund once the market recovered 10% from its low.

The results are remarkable. In Alliance’s modelling, the investor who did nothing for 30 years ended up £182,000 better off than their impatient counterpart. That’s quite some reward for showing restraint – and quite some penalty for trying to second-guess the market.

Why have patient investors done so much better? Essentially, there are two reasons. The first is that no-one is capable of consistently calling stock market movements correctly in advance – share prices are simply too unpredictable. Inevitably, this means investors who regularly move money in and out of their pots end up trading at the wrong moment – they miss out on periods when share prices are rising, for example.

The second thing in patient investors’ favour is what Albert Einstein once described as the eighth wonder of the world – the power of compound interest. Very simply, once you start earning a return, you earn money on the money you’re making as well as the money you started with. The effect is exponential – and over time, it makes an enormous difference.

Impatient investors, by contrast, do not get so much benefit from the power of compounding. Each time they miss out on positive return by being out of the market, they’re also missing out on the potential to earn returns on that return in future. It’s an exponential effect in the opposite direction.

Hold your nerve

No-one likes seeing the value of their investments fall. But it is important to remember that those falls are just paper losses until you lose your nerve and decided to sell. At that stage, you’re crystallising your loss – turning a paper-based fall in the value of your investment into an actual fall – rather than giving your investments a chance to bounce back.

The price you pay by doing that is what Alliance Trust call an impatience tax. It’s a loss that you incur that investors prepared to hold on for the long term don’t have to worry about. “The stock market is designed to transfer money from the active to the patient,” the renowned investor Warren Buffett once said – the key is to ensure you’re on the right side of that trade.

Discover the value of staying power at alliancetrust.co.uk/patience

* https://stepstoinvesting.com/podcast/special-the-patient-investor-episode-2-with-financial-adviser-sam-sloma/

** The Profit from Patience Report, Alliance Trust, September 2022. About the research:

Model based on two investors each making an initial stake of £10,000 in Alliance Trust in 1992 and then adding 10% of the average national salary every month afterwards. By September, the patient investor remains in the market throughout, while the impatient investor sells 25% of their holdings whenever the market dips 5% in a single day and buys back in when the market recovers 10% in a single day using cash accumulated from monthly contributions, previous redemptions, and accrued interest. NB: The model uses the Alliance Trust share price as a proxy for the market.

Source: Alliance Trust

Disclaimer

When investing, your capital is at risk. The value of your investment may rise or fall as a result of market fluctuations and you might get back less than you invested.

TWIM is the authorised Alternative Investment Fund Manager of Alliance Trust PLC. TWIM is authorised and regulated by the Financial Conduct Authority. Alliance Trust PLC is listed on the London Stock Exchange and is registered in Scotland No SC1731. Registered office: River Court, 5 West Victoria Dock Road, Dundee DD1 3JT. Alliance Trust PLC is not authorised and regulated by the Financial Conduct Authority and gives no financial or investment advice.