Unless you suddenly win the lottery, achieving financial independence is not an easy task. It takes time to save and build a suitable nest egg, as well as building the experience required to manage that nest egg before you can quit the rat race and live off your savings.
Investing is the best way to grow your wealth. With interest rates at their lowest level in history, equities are one of the few remaining places where you can achieve an attractive return on your money without having to take on excessive risk.
One simple rule
To build a substantial savings nest egg, all you need to do is save more than you spend and put in place a regular savings plan. The earlier you start to save the better as, over time, the power of compounding will do all of the heavy lifting. And just like saving, to be a successful investor there’s one main rule you need to follow to be able to achieve the best return on your money.
Unfortunately, most investors fail to understand this point, and their performances suffer as a result. Indeed, according to the latest study from Dalbar, since 1984, the average US equity fund investor has lagged the market by an average of 7.3% per annum as they have jumped in and out of the market.
So what’s the answer? Well, studies have overwhelmingly shown that the only way to achieve the maximum returns from investing is to focus on the long term. This means ignoring short-term market bumps and instead concentrating on the estimated long-term growth potential of the companies you own.
Look to the long term
Concentrating on the long-term performance only might seem like an easy task, but most investors fail to grasp this concept, and as a result, their returns suffer.
For example, over the past 10 years, the FTSE 100 has booked both up and down years. In 2007 the index rose 7.4% before falling 28.3% in 2008. The index went on to increase 27.3% in 2009, and 12.6% in 2010, but then fell 2.2% in 2011. However, if you’d sold at this stage thinking that the index had no further left to run, you would have missed out on a gain of 10% in 2012, 18.7% in 2013, 0.7% in 2014 and 19.1% in 2016 (the index fell 1.3% in 2015).
Even though the FTSE 100 fell in three of the past seven years, during the past decade, it has chalked up a total return of around 80%. This example shows clearly that focusing on the long view is the best course of action for most investors. If you’d sold out in any of the down years, you would have not only crystallised losses but also you would miss out on the market’s recovery.
So overall, investing is the best way to build your nest egg but without a pateint investment horizon, you’re unlikely to unlock the full potential of your money.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.