Throughout my career, there have been many market shocks and corrections, from the global financial crisis back in 2008, the end of quantitative easing and oil price crash of 2014, the start of the Russia-Ukraine war in 2022, and, of course, the Iran conflict.
During these turbulent times, a common reaction from investors has been: “I’m going to wait for things to get better before entering the market.”
While many assume entering the market during a volatile period is risky, waiting to make an investment entirely is far more detrimental to growth, and is the biggest risk factor to achieving financial goals. The simple truth is there is no good or bad time to enter the market – the only consideration should be time spent in the market.
Take the scenario of a 40-year-old with $200,000 of savings, looking to retire with an annual income of $50,000 aged 60. To reach their retirement target, an additional investment today of $228,000 would see this goal met comfortably. However, delaying this decision by five years increases the investment required to $360,000.
It’s a similar story with monthly investing, a regular monthly investment of $1,530 for 20 years achieves the same retirement goal, which increases substantially to $2,375 by waiting five years. And as all expatriates know, five years passes by in the blink of an eye.
There will always be a reason not to invest, but with every year that passes, the cost of waiting increases exponentially. In the example above, delaying by one year increases the lump sum required by $24,000. But why does a reduced investment time frame affect returns so much? The answer lies in compounding growth, which a certain Albert Einstein referred to as the eighth wonder of the world.
The power of compounding
Compounding is when money earns money, with the earned money then also earning money. For example, $100 grows by 10 per cent to give $110 – the next year it’s the $110 that earns 10 per cent, not the initial $100.
At first, these gains appear small and progress feels slow. It may be easy to think investing isn’t worth it. However, over time, the gains become larger as the investment grows exponentially. A common analogy refers to a snowball rolling downhill, small at first, but getting larger as it picks up more snow. The size of the snowball at first matters less than the length of the hill it rolls down. The longer the hill, the larger the snowball will become.
The power of compounding can often be underestimated. We tend to think in linear terms, with effort and reward measured proportionately. Compounding works differently, with small steps today bearing substantial fruits in the future, which can create a psychological challenge for some. Modest returns over a longer time horizon will beat higher returns achieved fleetingly.
While compounding is beneficial to investment growth, interruptions are equally as costly. Investing is for the long term, but panic selling during market downturns, or withdrawals from the investment will damage returns. It’s vital to stay invested during market volatility, and to have emergency funds in place to pay for any unforeseen costs, to keep your investment intact and compounding year-on-year.
The late Charlie Munger, renowned investor and business partner of Warren Buffett, once said: “The first rule of compounding is to never interrupt it unnecessarily.”
The power of compounding can also have negative effects, such as debt compounding, fee compounding, and inflation compounding. Inflation is the purchasing power of money over time and generally increases every year. This means if your income, savings, and investments are not rising in line with inflation, each year, you become progressively poorer. Investing over the long term is a hedge against inflation, ensuring you can afford the lifestyle you want.
Waiting to invest also has a direct link to risk exposure, which can become uncomfortable for some investors. Take the example of a 30-year time horizon with 7 per cent returns to comfortably achieve a financial goal. By halving the time horizon to 15 years, the required investment returns to achieve the same goal will increase to 15 per cent to 16 per cent.
This level of investment return, while still achievable, involves taking a much higher level of risk to generate, which, in turn, exposes the investor to high levels of market volatility. Some may feel uncomfortable with the large peaks and troughs associated with this level of risk and therefore dissuade them further from starting the investment, creating a vicious circle with the individual putting off the decision to invest indefinitely.
Even in circumstances where the investor is willing to take increased levels of risk to make up for lost time, this is not always a wise decision. The increased levels of volatility the investor is exposed to may not always work in their favour, as there is a higher probability of a market sell-off immediately before the investment funds are needed.
Chasing investment returns in a shortened time horizon is never an ideal solution; planning-led investing with moderate returns over a sustained period of time is a more efficient and less stressful method.
The endless news cycles and social media feeds will always present reasons to delay making an investment. Bad news sells, good news doesn’t. Market highs often don’t make headlines, but a market sell-off definitely does.
If you are considering making an investment for your children’s future, your dream home, or for a comfortable retirement, start small and start today. Your future self will thank you for it.
Always take professional advice from a trusted source before investing. Note that examples shown above assume balanced investment returns of five per cent per annum unless otherwise stated.
Chris Keeling is founder and senior executive officer at Metis
