Whether you're just starting to think about investing or have been invested in the markets for years, here are a
few concepts to keep in mind.
Starting to think about investing
Get off the Sidelines
Investing sooner can make a big difference in the long-term growth of your investments.
- Purchasing power: Investing can help you keep up with inflation so you don't lose purchasing power.
- Compounding: Compounding refers to the ability of an investment to generate earnings, which are then reinvested in order to generate their own earnings.
- Market timing: You could miss out on crucial gains, which typically come after dips in the market, by being on the sidelines for even a few days.
- Long-term growth: Market volatility is normal and expected, but long-term growth can beat short-term fluctuations.
Investing for the Long Term
Negative events in the media may cause people to react emotionally and lose sight of their investment strategy. In the past three decades, there have been a number of events that may have kept investors on the sidelines.
When you look at the big picture, as of December 2015, over the last 30 calendar years, the S&P/TSX Composite Index gained approximately 864% or 7.8% per year and 21 of the 30 years had positive returns.
Diversifying across a number of asset classes and geographic regions gives your investment portfolio a built-in ability to potentially benefit from each year's top performers, while seeking to reduce overall portfolio risk.
As an example, following the infamous market crash of 2008, most asset classes achieved positive returns in the immediate aftermath, giving credence to the stay-invested-for-the-long-term philosophy. Many investors could have recovered a majority of their 2008 losses in a relatively short period of time if they remained invested in a diversified portfolio of equities and fixed income assets.
Tax-Efficient Cash Flow
Ensuring your portfolio is invested in the most tax-efficient way is a key consideration when planning for your future. If you are seeking cash flow, tax-efficiency is also paramount. The good news is that there are a number of income options to choose from.
It's important to understand their differences as they are not treated equally from a tax perspective. Consider the after-tax net-return value of $100 from these different types of investment income held in a non-registered account:
|Interest||Dividends||Capital Gains||Return of Capital|
Surviving market events
Power of Staying Invested
Trying to time the market may cause an investor to miss out on long-term growth. Let's take a look at the impact of missing the best one percent of days over 30 years while investing $10,000 in the S&P/TSX Composite Price Index ("TSX").
Source: TD Asset Management Inc. and Bloomberg Finance L.P.
For illustration purposes only. The index returns are shown for comparative purposes only. Indexes are unmanaged and their returns do not include any sales charges or fees as such costs would lower performance. It is not possible to invest directly in an index. The graph is used only to illustrate the effects of the compound growth rate and does not reflect future values of any fund or returns on investment of any fund.
Two things to keep in mind:
- A considerable portion of long-term gains can be attributed to a relatively small number of good days. In this example, missing the best one percent of days reduced the end value of investor's portfolio by over $42,000.
- Many of the best days shown in this example occurred soon after the bad days. An investor who sells their investment on a bad day may miss out on the good days that follow, thus potentially reducing long-term portfolio value.
Emotional investing may influence you to buy and sell at inopportune times and eventually lose confidence in your financial decisions. As an investor, it's important that you understand the emotions related to investing in order to help avoid this cycle and invest for the long term.
Source: Westcore Funds Denver Investment Advisors LLC, 1998
Sequence of returns
While no one can predict when volatility may strike, markets have historically bounced back over the long-term. For retirees however, periods of high volatility can have a serious impact on their savings if the sequence of returns is unfavourable.
If a retiree is withdrawing five percent of their savings per year, then the asset base will likely decline over time (depending on overall returns). As a result, investment returns that occur at the beginning of decumulation impact a greater number of assets, thereby setting the stage for the portfolio's future income flow. On the other hand, the effects of investment returns in later stages of decumulation are not as pronounced as they impact a smaller amount of assets.
Source: Assumption: Person 1 and Person 2 have an annual withdrawal of $15,000 per year. Using the S&P/TSX Composite PR index. Dividends are not reinvested. 1Person 1's returns reflect the S&P/TSX average calendar year return between 1993 and 2002. 2Person 2's returns reflect the S&P/TSX average calendar year return between 2001 and 2010.
Timing matters. The sequence of returns at the beginning of retirement often has the greatest impact on future income flow. Take Kim and Dan, for example. Each are withdrawing $15,000 per year in retirement income, and each earns a similar average return over ten years. However, Kim’s returns are favourable during the first few years of retirement while Dan’s are not. Dan’s unfavourable returns early in retirement, combined with his need to withdraw income, has left his retirement account significantly depleted.