The problem with investing for the longer term

Popular wisdom has it that one should just buy a share, or the share index, and hold on to it. That over the longer term you will make your money. That paying an active fund manager is not worth the money because over time they do not beat the market. The problem with these statements is that they could be misleading and one should dig a little deeper.

If you look at the graph above depicting the American share market over the last 100 years, it is easy to see that if you invested money in 1920, you would have made a lot of money if you cashed out today. But what if you invested in the early 1960s? You would have had to wait until the early 1980s to start making money. That is a 20-year wait. There are other statistics that show that over the last 125 years or so, you always had to wait on average 20 years to have a 100% guarantee of a rolling positive return from American stock markets.

The statement that active fund managers do not beat the index over time, is only partly true. There are some fund managers that beat the index over a 5- to 10-year period after costs but they are few and far between. The question is what can you do about it? The answer, unfortunately, is not that simple. One of the golden rules of investing is that one should not try to time the market, but rather look at valuations.

When you invest in the index, you have to make sure that the general market is not overpriced at that time. Theoretically, this problem should not occur when investing with a fund manager because they should evaluate the shares they buy on a continuous basis. If you did get the valuation right at time of investing and the market goes up, one should rebalance the investment and take some profits as the market becomes more expensive. This should once again be the responsibility of the fund manager if you are using one.

So the best option is to find fund managers who can invest in undervalued shares without having to worry about the overall level of the market and monitor these managers to make sure that they do not become passive. Together with this, it is advisable to diversify your investments between different asset classes and geographical areas even if you have a 20-year investment time horizon because there will be surprises which you can benefit from if you pay attention. Unfortunately, there will always be some investments made at the wrong time which will take a very long time to turn a profit.

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