Time in the market

Amidst the recent political and market uncertainty it is all too easy to lose sight of the importance of investing for your long term Financial Wellness.

Sophisticated investors are well versed with the “time in the market not timing the market” arguments and while they border on the trite, that does not diminish their significance. Likewise the rather hackneyed quote from Einstein that compound interest is the “eighth wonder of the world”. It’s easier to see the wonder, of course, when interest rates are materially above zero. You don’t need to be a Nobel prize winning theoretical physicist to calculate that a rate of interest close to zero remains pretty close to zero even when compounded for a very long time. The implication for us is that it is, on balance, better to be in than out. It is always difficult to top up investments when the going is tough but it can be just as heart wrenching to add to a position once the market has rallied and, not only is it difficult, it could be less rewarding to boot.

When it comes to inflation and real returns on assets the inverse is the case. Purchasing power is reduced on a compounded basis by the effect of inflation. Ronald Reagan (of all people) is quoted as referring to inflation as “as violent as a mugger, as frightening as an armed robber and as deadly as a hit-man”. The imagery is pure Hollywood but I think the metaphor is unsuited to inflation’s impact on the real value of assets. Reagan was right about the outcome but wrong about the experience. That is because rather than being overt like a mugger or a robber inflation is covert, silent, almost insidious but the effects are no less crippling over the long term.

That is why when working with advisers all over the globe we ensure we talk about clients’ long term financial wellness. Inflation, if left unchecked, will compound relentlessly, silently denuding the value of the pound in your pocket. Clearly it is sensible to aim for a strategy that delivers returns in excess of inflation. Both greater time lines and greater risk tolerance enhance the scope for investments to exceed inflation rates. The good news is that investment assets should provide risk premia that result in returns greater than inflation. The bad news is that those returns can come in fits and starts which is totally at odds with inflation based time series which tend to be very low volatility. That is why we believe that investors needing to beat inflation should look for investment managers deliberately targeting real returns.

Periods like this do not help because investors are minded to defer investments. The default parking space for uninvested capital is cash but the interest rates available on cash presently are, on the whole, below the prevailing level of inflation meaning that cashed up investors are not simply standing still in real terms, they are going backwards. I believe that this is a scenario that precious few can afford. Most people do not have the resources to retire on the basis of their current savings meaning that this capital has to work for them – it has to grow – as they move towards retirement. It is imperative that investors ensure that their money works as hard for them as they did for it, otherwise they run the risk of a vastly reduced standard of living in retirement or even, in more extreme cases, no retirement at all.

James Klempster, CFA