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Prudent Investor Update, June 12, 2019

The Paradox of Investing for the Long-Term

In today’s fiscal environment, when every dollar counts, making wise investment decisions can help municipalities pay for important capital projects. The paradox, though, is that investments that tend to deliver better returns over the long run are more likely to experience short periods with poor returns.

A willingness to ride out short-term losses, though, can add millions to the bottom line, according to ONE Investment’s analysis of a real-life municipal portfolio. ONE Investment analyzed potential results of an Ontario municipality that held both short and long-term investments with the program. The name of the municipality is being withheld to respect client confidentiality.

ONE compared the municipality’s bottom line if it had invested $10 million using a long-term strategy versus keeping full liquidity and safety in short-term investments at all times.  To reflect the worst possible scenario, the analysis started just before the 2008 global financial crisis, when the Canadian stock market fell by 33%.

ONE compared the results of  keeping all the money in (1) Money Markets, (2) 50% Money Market
+ 50% Short Term Government Bonds or (3) 30% Canadian Stocks + 35% High quality corporate bonds
+ 35% Short-Term Government Bonds.

Using various market indices for the years 2008 to 2018, the Money Market’s annualized return was  1.2%, compared to 1.9% for the 50/50 portfolio and 3.7% for higher risk 30/35/35 portfolio. Despite negative returns in several years, the overall benefit was significant. In fact, in dollar terms, the $10 million was worth nearly $12.8 million, 17% higher than if the funds had been left in Money Market.

Here’s what you can conclude:
  • Due to the power of compounding, small differences in long-term returns add up to large amounts in ending values.
  • The most important determination when investing for the long run is finding the right level of risk for a portfolio:  we can intuitively appreciate the annual effect of taking on too much risk, however, we may not fully appreciate the long-term impact of not taking on enough.  This cost needs to be considered in investment decisions.
  • An understanding of risk tolerance is something that may evolve over time with financial and investment planning experience.  Although it is almost impossible to predict market outcomes in any year, long-term market behaviour has been more consistent.
  • The long-term investments in the study are all fully liquid and can be accessed at any time.  However, the riskier ones fluctuate in value more, so it is crucial that they be left invested in their markets as long as possible.
Learn more about this analysis by reading the full case study, which further explains time frames, risk tolerance, how to interpret the returns. It also explains the assumptions made for the analysis.