Adam Smith, ‘the father of economics’, was a 19th-century economist, philosopher and thinker who said, “A stock doesn’t know you own it.” All investors at some point become painfully aware of this reality. We are all mortal beings with a specific life span; not so the stocks in which we invest. Stocks that have a value today will have a value in the future irrespective of who owns them.
All investors need to fully understand the impact of the two greatest risks they face beyond their own behavioural errors: market risk and inflation risk. Market risk cannot be eradicated; it must be managed. Inflation risk must be hedged against.
Return on invested capital is fundamentally a function of interest rates and the time over which the capital is invested. The longer our time horizon, the more risk assets we can sensibly hold and the greater our risk-adjusted return on capital. Thus, conventional investment wisdom dictates that older people should invest in bonds for higher income and greater safety, and that we should determine how much investment capital is allocated to bonds by subtracting our age from 100. However, a wiser and generally more effective decision would be to allocate our capital to a longer investment time horizon, not merely our lifetime. The people we love and the charities we support will probably outlive us, so why shouldn’t our investment time horizon include them? An investment strategy should not be predicated on age but on our investment objectives and our desired investment outcomes.
Albert Einstein referred to a table of compound interest as the greatest wonder of the world. It is this mathematical fact of compound interest that increases capital invested in the stock market and creates wealth over time. You may recall the story of the vizier to whom the sultan granted anything he wanted as a reward for saving his empire. The vizier asked the sultan to give him just one grain of wheat on the first square on a checkerboard, just two on the next, just four grains on the third and so on. The sultan marvelled at how cheaply he had managed to be released from his obligation to the vizier because he failed to understand the power of compounding. Anything doubled 64 times will balloon and balloon again. Eventually, to avoid shame, the sultan turned over his entire empire to the vizier.
We should not change our investments just because we reach a certain age. If you can afford to own fine paintings or a collection of fine wines or classic cars, you would not sell them simply because you turned eighty or ninety; likewise with investments. Why not hold a long-term strategy, with the advantage the increased risk-adjusted return on invested capital will bring to your family and future generations? Although I am 73 years old, my preferred investment time horizon is 50 years.
Jeremy Blatch TEP