In 1974, sociologist Dr. Edward Banfield of Harvard University wrote a book entitled, “The Unheavenly City.” He described one of the most profound studies on success and priority setting ever conducted. Banfield’s goal was to find out how and why some people became financially independent during the course of their working lifetimes.
He finally concluded that the major reason for success in life was a particular attitude of mind. Banfield called this attitude “long time perspective.” Time perspective referred to how far you projected into the future when you decided what you were going to do or not do in the present.
One example given in the book was the decision facing many school leavers – get a job or study further? Having a short time perspective would point to getting a job because you start ‘making money’ sooner than studying. However, research has shown that over the duration of a career, the average skilled or qualified person can earn more than double that of the average unskilled worker, despite starting to earn an income a few years later.
This attitude of a long time perspective is often found in successful entrepreneurs and executive managers in large corporations. This ability to take a long time perspective sometimes leads to decision-making that does not make sense for outside observers, who often have a short time perspective when judging such decisions. I sit in wonder when I listen to people complaining about the traffic jams being caused by the road works on the M1 South. “We’ve got to deal with this traffic for another 2 years!” is the usual refrain. Having driven that road for the past 20 years, 2 years seems insignificant. Over the long-term it is a good thing, over the short-term I’ve adjusted my routing and I actively avoid the M1 South.
A long time perspective for investors needing income
I read an article where a number of financial advisers were asked for their opinions on where investors could invest for income. A ‘highly rated’ adviser suggested a product with an investment term of less than 3 years because it was currently offering a high yield. My immediate thought was “what happens when the product matures in less than 3 years time?” My faith in my profession was restored when another lesser known adviser recommended a combination of asset classes including a chunk in equities.
Consider for a moment two retirees who were facing the decision of where to invest their R1m pension on 1 January 1999. Income funds are yielding over 13% and equities are yielding about 5% at the time. Pensioner A has a short time perspective and chooses the Income fund yielding 13%. Pensioner B has a long time perspective and invests in the equity fund yielding 5%. Pensioner A earns a higher rate of income until 2003 when income growth (and a bit of luck) kicks in for Pensioner B. B then earns more than A from then on, earning as much as 3x more income in some years than A. Cumulatively, A earns more than B until 2006 as a result of the large gap in the beginning. However, come end December 2010 – A has earned approximately R1.7m income and his capital is worth R1.07m. Pensioner B on the other hand has earned over R3.6m income and his capital is worth north of R8m.
(It is never wise for any investor to only invest in one fund or one asset class – the best solution for most pensioners would probably be a combination of both funds, and other funds such as property and offshore).
The difference between income funds and equity funds is that the yields from income funds are based on largely on the interest rate cycle. The yield from equities comes from dividends paid by companies. The thing with the interest rate cycle is that it varies around an average over time. Interest rates go up, then they come down, then they go up again. Dividends on the other hand start at a point and grow from there. The growth rate in dividends varies over time, and can be negative at times, but generally maintains pace with inflation. At some point the effect of compounding kicks in – and the income from equities outstrips that of fixed interest alternatives. Property income also shares this trait with equities – growth compounding over time leading to a higher income over time.
Why are more investors invested in cash and bonds then?
One possible reason is that equities and property are volatile over the short-term from a capital perspective. This deters a lot of investors, and retirees / pensioners in particular are put off by volatility. It is a very uncomfortable thing seeing one’s investment down by double-digit percentages, and then still drawing income from such investments. See the capital performance of the two funds referred to in the graph above. There are numerous periods where the capital value falls more than 20%. Many income investors are unnerved by this. They still equate the capital value of an asset to wealth, and ignore the ability of the asset to generate income over the long-term.
Another reason income investors favour bonds and cash over property and equities is that many retire without having saved enough for retirement, and are then forced into a short term mentality where they have to invest where the highest yields currently are. A third possible reason, as mentioned earlier, even ‘reputable’ market commentators are sometimes prone to a short term mentality.
A long time perspective and investing for growth
Financial and investment articles published in December and January in particular often contribute to short-termism by growth investors. This year they may have read articles like “where to invest in 2016” or “the A – Z of investing in 2016” or “stock picks for 2016”. Investors’ language often betray this short-term perspective. I often get asked “where is the best place to put my money at the moment” or “what’s doing well now”? Investor behaviour also tends to show up this short-term thinking – consider unit trust sales data which show the highest inflows to equities, property, and offshore assets after the respective markets have delivered strong returns.
While these assets are volatile in the short-term, this volatility fades in the long-term, with long term equity returns around the 13 – 15% p.a. level over time. A major threat to an investor’s wealth is inflation. Inflation is a long-term phenomenon which does not impact investors meaningfully over the short-term. By the time it does become an issue for investors, it is often too late for them to do anything about it. Equities and property have both outperformed inflation significantly over the long-term, with cash and bonds marginally outperforming over time, and often under performing over the short term. Once tax has been factored in, cash and bonds struggle to beat inflation.
Taking a truly long-term perspective is about understanding what the best course of action to take now that will lead to the best outcome over time. It is not simply investing in something for a long period of time and hoping for the best. It is an attitude that needs to be developed in all spheres of life, which would make it easier to apply to investment decisions.
The original version of this article appeared on Moneyweb (www.moneyweb.co.za) on 27 February 2012 and was written by myself. This version has been edited and updated.