Holding Equities for the Long Term: Time vs. Timing
Legendary investor Warren Buffett is famous for his
long-term perspective. He has said that he likes to make investments he would
be comfortable holding even if the market shut down for 10 years.
Investing with an eye toward the long term is particularly
important with stocks. Historically, equities have typically outperformed
bonds, cash, and inflation, though past performance is no guarantee of future
results and those returns also have involved higher volatility.
It can be challenging to have Buffett-like patience during
periods such as 2000-2002, when the stock market fell for 3 years in a row, or
2008, which was the worst year for the Standard & Poor's 500 index since the
Depression era. Times like those can frazzle the nerves of any investor, even
the pros. With stocks, having an investing strategy is only half the battle;
the other half is being able to stick to it.
Just what is long term?
Your own definition of "long term" is most important, and
will depend in part on your individual financial goals and when you want to
achieve them. A 70-year-old retiree may have a shorter "long term" than a 30-year-old who is saving for retirement.
Your strategy should take into account that the market will
not go in one direction forever — either up or down. The benefits of patience
Trying to second-guess the market can be challenging at
best; even professionals often have trouble. According to "Behavioral Patterns and Pitfalls of U.S. Investors," a 2010 Library of Congress report prepared for the Securities and Exchange Commission, excessive trading often causes investors to underperform the market. Another study, "Stock Market Extremes and Portfolio
Performance 1926-2004," initially done by the University of Michigan in 1994 and updated in 2005, showed that a
relatively small number of months or even days account for most market gains and losses. The return
dropped dramatically on a portfolio that was out of the stock market entirely
on the 90 best trading days in history. Returns also improved just as
dramatically by avoiding the market's 90 worst days; the problem, of course, is
being able to forecast which days those will be. Even if you're able to avoid
losses by being out of the market, will you know when to get back in?
The power of time
Though past performance is no guarantee of future results,
the odds of achieving a positive return in the stock market have been much
higher over a 5- or 10-year period than for a single year.
Source: London Stock Exchange Group, 2024. S&P 500 composite total return for the period December 31, 1993, to December 31, 2023. Ranges consider the 30 one-year periods, 26 five-year periods, and 21 ten-year periods from 1994 to 2023. Keep yourself on track
It's useful to have strategies in place that can help
improve your financial and psychological readiness to take a long-term approach
to investing in equities. Even if your're not a buy and hold investor, trading discipline can help you stick to a long-term plan.
Have a game plan against panicHaving predetermined guidelines that anticipate turbulent
times can help prevent emotion from dictating your decisions. For example, you
might determine in advance that you will take profits when the market rises by
a certain percentage, and buy when the market has fallen by a set percentage.
Or you might take a core-and-satellite approach, using buy-and-hold principles
for most of your portfolio and tactical investing based on a shorter-term
outlook for the rest.
Remember that everything's relativeMost of the variance in the returns of different portfolios
is based on their respective asset allocations. If you've got a
well-diversified portfolio, it might be useful to compare its overall
performance to the S&P 500. If you discover you've done better than, say, the
stock market as a whole, you might feel better about your long-term prospects.
Look at performance over longer periodsDon't forget to look at how far you've come since you
started investing. When you're focused on day-to-day market movements, it's
easy to forget the progress you've already made. Keeping track of where you
stand relative to not only last year but to 3, 5, and 10 years ago may help you
remember that the current situation is unlikely to last forever.
Consider playing defenseSome investors try to prepare for volatile periods by
reexamining their allocation to such defensive sectors as consumer staples or
utilities (though like all stocks, those sectors involve their own risks).
Dividends also can help cushion the impact of price swings.
If you're retired and worried about a market downturn's
impact on your income, think before reacting. If you sell stock during a period
of falling prices simply because that was your original game plan, you might
not get the best price. Moreover, that sale might also reduce your ability to
generate income in later years. What might it cost you in future returns by
selling stocks at a low point if you don't need to? Perhaps you could adjust
your lifestyle temporarily.
Use cash to help manage your mindsetHaving some cash holdings can be the financial equivalent of
taking deep breaths to relax. It can enhance your ability to act thoughtfully
instead of impulsively. An appropriate asset allocation can help you have
enough resources on hand to prevent having to sell stocks at an inopportune
time to meet ordinary expenses or, if you've used leverage, a margin call.
A cash cushion coupled with a disciplined investing strategy
can change your perspective on market downturns. Knowing that you're positioned
to take advantage of a market swoon by picking up bargains may increase your
ability to be patient.
Know what you own and why you own itWhen the market goes off the tracks, knowing why you made a specific investment can help you evaluate
whether those reasons still hold. If you don't understand why a security is in
your portfolio, find out. A stock may still be a good long-term opportunity
even when its price has dropped.
Tell yourself that tomorrow is another dayThe market is nothing if not cyclical. Even if you wish you had sold at
what turned out to be a market peak, or regret having sat out a buying
opportunity, you may get another chance. If you're considering changes, a
volatile market is probably the worst time to turn your portfolio inside out.
Solid asset allocation is still the basis of good investment planning.
Be willing to learn from your mistakesAnyone can look good during bull markets; smart investors
are produced by the inevitable rough patches. Even the best aren't right all
the time. If an earlier choice now seems rash, sometimes the best strategy is
to take a tax loss, learn from the experience, and apply the lesson to future
decisions.
|