Why a long-term investing approach is likely to offer better returns

It relies on the benefits of compound interest and reduces the impact of short-term fluctuations

Short-term market forecasting is a challenging discipline. Getty Images

Investing in markets can take many forms – from daily trading to long-term portfolios and rotation strategies.

Some investors choose initial capital investments, while others prefer a savings plan to manage limited liquidity.

Regardless of the approach, it is essential to understand your strategy and be prepared for volatility such as recent market fluctuations.

Short-term market forecasting is challenging. This is why time is a valuable ally; a well-structured portfolio can benefit from overall economic growth, which tends to occur approximately 80 per cent of the time while slowdowns account for the remaining 20 per cent.

Timing the market, or the attempt to buy at lows and sell at highs, is known for being complex and risky. In contrast, focusing on long-term growth provides more reliable advantages.

Evaluating both strategies carefully is essential for making informed investment decisions.

Market timing demands precise short-term predictions, which are exceptionally challenging due to the wide range of factors influencing the market, from global economic indicators to geopolitical events.

Trying to time purchases and sales with market peaks and troughs often results in missed opportunities for long-term growth.

Historically, the stock market has generally trended upwards and attempts to enter and exit for short-term opportunities can result in substantial losses and high transaction costs.

Investing with a long-term horizon allows investors to benefit from overall stock market growth. Additionally, it helps mitigate the impact of short-term fluctuations, enabling investors to weather downturns and capitalise on recoveries.

Long-term investing also promotes portfolio diversification, reducing risk associated with the performance of individual stocks and market swings.

Since the Second World War, the US has experienced 12 recessions, each lasting for an average of 10 months, but the subsequent recovery has been much longer – about 64 months.

These recessions have become less severe because of the evolution of central banks and the shift towards a more service-orientated economy.

Although each recession and bear market have their own characteristics and can generate concerns, the resilience of economies and businesses shows that recovery is not only possible but likely.

While central banks and governments respond to problems, markets recover and tend to grow over time. For example, the S&P 500 has delivered an average annual return of 10 per cent. This refers to a long-term historical average over nearly a century, typically calculated from the late 1920s through the present day. The average takes into account both bull and bear markets, showing that despite short-term volatility, markets tend to rise over the long term.

Bull markets, with their prolonged uptrends, are built on the back of bear markets. The latter, characterised by declines of more than 20 per cent in indices, tend to occur during economic recessions, marked by reduced business activity, typically lead to higher unemployment rates and lower consumer spending, which further pressures the stock market.

On average, a bear market lasts about 19 months and results in a contraction of 38 per cent. In contrast, bull markets are more enduring, four times as broad, and benefit from lower inflation and interest rates following recessions.

The risks of market timing, such as the difficulty of predicting market movements and potential losses, outweigh the benefits.

Focusing on steady long-term growth is more advantageous as it allows the investor to capitalise on general market trends, use the power of compound returns, and reduce the impact of volatility through a prolonged approach.

As Charlie Munger, who passed away last year, said: “It’s waiting that helps you as an investor and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.”

Gabriel Debach is market analyst at eToro.

Disclaimer: This is not investment advice.