Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
One of the simplest questions faced by an investor is also one of the most important; how long should you hold an investment for?
An oft-cited statistic about stock markets is that they deliver, on average, returns of around 7-8%. This isn’t guaranteed, of course, since the future is unknowable by anyone, but it’s what history has told us we should expect.
So if the markets generally rise, on average, why does the length of time you hold an investment, known as your ‘holding period’, matter so much?
Why markets rise over the long term (usually)
In a functioning economy, with businesses working hard to increase their profits, stock prices should generally rise over time. This is obviously good news for shares and the people who hold them.
But, as everyone knows, share prices fluctuate. For instance, a company can be subject to bad news which causes its share price to fall. In this case, how long you hold the investment becomes very important. As long as the company isn’t a dud and going out of business, a longer holding period gives you more latitude for good things to happen, to correct the falls from the bad news. For example, there could be changes to the businesses or its management, the economy could improve and any political problems could resolve themselves.
In other words, being a long-term ‘investor’, rather than a short-term ‘trader’, means you could benefit from capitalism’s knack for identifying problems and finding solutions.
Longevity reduces volatility
To illustrate this principle, here is a chart showing the minimum and maximum returns from UK stocks going back to 1900, across various holding periods:
Minimum and Maximum Annualised Nominal Return %, by holding period (UK Stocks: 1900 - 2017) – DMS Dataset
As you can see, the range of potential returns in any single year is huge - you could see big upside but you could just as likely see large downside too. But, once you increase the holding period, the benefits of a longer time horizon start to be felt, reducing the extremes of potential returns.
It’s only in longer holding periods, which allow you to ride out the highs and lows, that we move towards the average annual historic return for UK shares, of just over 7%. Perhaps more significantly, you can see that the longer the holding period, the lower the chance of loss as the minimum average return increases.
Conversely, when you react to short-term news and chop and change investments, you’re playing in the left-hand side of the above graphic. Each new investment potentially restarts the holding period clock so, whilst you may get better returns from changing, you may also get far worse returns, particularly if you don’t hold onto the new investment for long, either.
How does it work with funds?
So how does that apply to funds? Typically, a fund will require a certain amount of time for its strategy and objectives to be realised – exactly how long will be determined by the fund manager. To take the example of the AJ Bell funds we manage, we suggest a time horizon of at least five to ten years. In an ideal world, the fund manager’s time horizon and the investor’s holding period will be aligned and when this happens, a happy relationship emerges. In this situation, as an investor, you should end up receiving (shy of any major catastrophes) the outcomes advertised in the fund’s promotional material.
So it’s important to ask yourself, when deciding whether to keep or sell a fund you own: what’s my holding period, what is the fund’s time-horizon, and are they aligned?
These articles are for information purposes only and are not a personal recommendation or advice.