The Importance Of Different Yield Durations Across Investments

June 25, 20214 min read
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Investing is a vital step towards securing your future. But good results in investing can take time. In the short term, the price of assets can seem to be random. As JP Morgan supposedly said, the stock market will fluctuate on any given day. Even in the medium term, think 3-5 years, economic cycles can work against investors – ask anyone who started investing in the stock market in January 2000 or in 2007. Even January 2020 investors took a hit for a few months, and it felt like it could be a lot worse.

Having a long-term mindset towards investing is one of the biggest hacks to success and to avoiding these dilemmas. Here are a few reasons why extending your investment horizons beyond a few years, and considering longer-term investment opportunities that have the potential to provide higher yields might make sense for your investment portfolio. 

Term Premia 

With all else equal, investors are usually compensated for taking on a longer duration, because risks can sometimes be elevated due to the additional length that capital is tied up for. Investors should consult each term and individual offering to determine whether they’re being compensated fairly. Opportunities outside of the stock market, such as private alternative investments, are usually associated with longer durations given the complex nature of the investment strategies themselves. More time is needed for these strategies to play out and to come to fruition in comparison to simply trading equities. 

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Locking In Higher Rates, And Reinvestment Risk

Rolling over short-term investments consistently is time consuming and increases market and reinvestment risk. Features like automatic reinvestments can help ensure that your portfolio is hands-off and working hard for you. In addition, securing longer term deals often allows for locking in higher rates.

Flexibility is often desirable for those investors that have short-term liquidity needs, however, if an investor has a long-term savings goal (say saving for a future child’s college education) the need for liquidity becomes less of a concern. Investors who are able to commit capital for longer periods generally will be rewarded in the form of potentially higher yields and the difficulty of trying to time market entry (which is virtually impossible for most average investors) is removed. When capital is being returned frequently, chances are you won’t be able to secure the same short-term rate, ultimately reducing the average yield of your portfolio.

One of the biggest mistakes many individual investors make is being too active. Dalbar, an investment research firm, has found over the years that individual investors’ returns badly trail the leading indices due to bad timing and too much trading. Throw in any transaction fees and short-term capital gains that get taxed at a higher rate, and the bar for success as a short-term investor is much higher. 

Keeping one’s focus on the long-term helps reduce the incentive to juggle positions, avoids attempting to time the market, and positions the investor to benefit from long-term capital gains tax rates. 

Compound Interest: The Most Powerful Force

One of the biggest benefits to long-term investing is that idea of letting your money go to work for you. How it goes to work for you is by compounding, that is, earning interest on previously earned interest.

Here’s a chart to illustrate:

Table showing how compound interest could yield substantial returns with just a $10,000 investment

What you’re seeing is how much money someone would have if they started with an initial $10,000 investment. 

Pay attention to the widening difference in the returns at different annual levels. Since long-term investors are less likely to incur transaction fees or short-term taxes, their returns generally should, all things being equal, be higher. Their snowball of wealth gains momentum and grows faster as a result. Using our chart as a simplistic example, imagine if you achieved 8% annual returns but 50% of those returns were eaten away by taxes and other fees. The difference adds up over the years!

Putting It All Together – Adding In Long Term Investments

We invest to achieve goals in our life. To provide for one’s family, to afford a house, to plan a comfortable retirement. These are tangible goals that make a life rewarding, satisfying, and comfortable.

Aligning one’s investing with these sorts of goals will allow the investor to feel more confident in their investing. Not having to worry about hitting a target price next week, or worrying about this week’s negative headline or missing out on tomorrow’s positive headline, the long-term investor can stay focused on investing  so as to achieve these goals. 

Your needs aren’t just for the short term, so don’t just seek out investments with the same term and duration or yield. Consider longer-term investments, and figure out which longer-term investments make the most sense for your portfolio.