The main investment goal for many people is
to accumulate a
substantial amount of money over a lengthy period of
time. A perfect example of this goal would be
saving for retirement. In this scenario it is not uncommon for
individuals to invest money over a period of 30 or more
years. When such a lengthy period of
time is involved an investor would be wise to institute a
strategy that is able to use the years to his
advantage.
A person who invests for the long term is far less affected by
any short term volatility in the market. Whether or not the market
drops by one hundred points (or one thousand points) will likely
have no affect on market levels three decades in the future.
Consequently, these conditions provide the perfect environment for
relatively risky stock (and mutual fund) investments. These
investments offer a significant potential for growth, but they also
come with a higher level of risk. Let's examine a real world example
of how this might work.
Example
A man invests $10,000 into an aggressive mutual fund on his 30th
birthday. He wants to withdraw the funds upon turning 60. For the
first 5 years he gains 10% annually. (Total of $16105.10) At the end
of the 5th year the market crashes and he looses 20%. ($12884.08)
Over the course of the next 25 years his investments once again
average a 10% annual gain. When the gentleman turns 60 years of age
he will have access to investments totaling $139,595.22 Please note
that for the sake of simplicity this example was based on a single
lump sum investment. In reality, most investment plans call for
additional amounts of money to be saved over the course of time.
This illustrates that if an individual is saving for the long
term then he can typically afford to overcome some rough financial
times. In our example, the aggressive investments resulted in a 20%
loss when the market dropped, but this was more than offset by the
gains over time. However, it is very difficult for some people to
focus on the big picture. They become fixated on the possibility of
loosing money in the short term. Generally these people resort to
utilizing very conservative investments. And while this strategy
serves to protect their money from large drops, it also prevents
their money from making large gains. In the long run a person
is
better off (statistically) by choosing aggressive investments. However, it
is also important to realize that as a person draws nearer
to his goal it becomes much more difficult to make
up for any significant losses. At this point it becomes wise to shift
investments toward less aggressive positions.
