One of the basic principles of investing is that the longer your time horizon, the greater the yield you can generally expect. On certificates of deposit at the bank, you get higher interest on longer maturities. If you are buying US Treasury bonds, the 10 year bond usually has a higher yield than the 1 year bond. Conversely, if you are taking out a loan, you pay higher interest on a 30 year loan than on a 10 year loan.
If you’ve got a long time horizon, this seems like an easy way to maximize your returns. But there is no such thing as a free lunch—the only reason issuers will pay you more for a longer time to maturity is because they are hoping to get something out of it.
Some individuals may have short term outlooks, and be easily spooked out of the market. That’s bad news for investment companies and debt issuers who find their money reserves drying up when investors start cashing out. If investors lock into longer terms the companies are free to implement longer term strategies with less of a worry about investors abruptly pulling the rug out from under them. That is why they are willing to pay higher yields to keep the money in for longer.
It sounds like a win/win situation, but there are risks to buying longer term investments. A lot can happen in thirty years! Maybe the investment landscape changes and what looked like great returns at the time turns into chump change when newer investments start yielding more. Maybe the issuer runs into trouble, raising questions about the security of the investment. If you were holding a shorter term instrument, you might have avoided those problems.
The good news is that you, too, can benefit from a longer term perspective—without needing to lock your money away in illiquid long-term investments. If you are not jumping in and out of investments in response to short term swings you can cut down the drag on your portfolio and potentially enjoy better returns. Even better, you can specifically seek out more volatile investments that are less popular with investors and may command higher returns than more stable, popular investments. By investing for the long haul, you may enjoy the higher returns that may be available on long-term money.
And, because you did not actually have to lock in your investments for decades, you are still able to react to major upheavals. You can ride through the small bumps without hurting yourself by selling out low and still be able to pull out if you need to.
Of course, staying the course may be easier said than done. Tolerating volatility has been a path to higher returns in the past, but not everyone is capable of doing that. We believe there is an advantage to investing for the long term. But one may retain liquidity—the freedom to change tactics—instead of committing to a course for years or decades to come. Clients, if you want to talk about your time horizon, please call or email us.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
CD’s are FDIC Insured and offer a fixed rate of return if held to maturity.
Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.
This is a hypothetical example and is not representative of any specific investment. Your results may vary.
Investing involves risks including possible loss of principal.