Some of the simple wisdoms you hear throughout your life are actually good for you—such as eat your peas and carrots, and invest for the long haul. Neither one sounds sexy, but both are proven to pay off over time. When it comes to investing your most serious money we hear the phrase, “invest for the long run” over and over, but how long is long term?
For some people, “long term investment,” means holding on for 5-10 years. For others, it’s committing to a particular stock or fund forever, and there’s never a right time to sell. The reality, of course, is there are plenty of situations when getting out of a long-term investment is exactly the right decision so you can put that money to work someplace else. Monitoring and reviewing your positions is part of the process. But you have to consider who is making the sell recommendation. For a commission-driven broker in the business of selling transactions, moving money around is how he makes his living. A good advisor does the opposite, and helps you remain calm to keep you on course, especially when there’s drama.
In this post, I’ll explain exactly what it means to own investments long term, and why short- term results can be the enemy of wealth building.
Say No to Gambling
First and foremost, let me explain what long term investing isn’t. It’s absolutely not what you see on Jim Cramer’s TV show, Mad Money, which involves a one-man show focused on erratic buying and selling and is more about entertainment than serious investing. No, long term investing is about thinking ahead and planning how to have enough money for the rest of your life. It’s about how to diversify your serious investments, it’s not reacting with urgency, or trying to get lucky and make a few quick bucks. There’s a big difference between urgent and important. Planning for something as meaningful and long term as how you’ll live out the last 30 years of your life may not be urgent today, but most would agree it is important.
I’m picking on Cramer because millions of people follow his approach to investing (at least on his TV show) but it doesn’t qualify as an investment plan, and he’s the first to admit it. It’s simply a high-risk approach that can encourage inexperienced investors to make hasty decisions to pull the trigger based on emotions without fully understanding the long-term consequences of their decisions. The hyper-trading is really intended for people who want to play along using small amounts of money they can afford to lose. That’s why his show is called, Mad Money.
Now let’s talk about real life investing.
Enjoy the Ride
The historical record is clear: time and again, studies reveal long-term returns vastly outperform short term-returns. It doesn’t matter which investments: stocks, bonds and real estate are always a better investment when you take the long view. That said, I’m not suggesting that investing long term means not touching your positions. Pruning (selling or adjusting) your portfolio is part of a successful long-term approach, such as when you need to re-balance your portfolio to stay within your guidelines, free up capital, or if you’ve met your investment targets.
So what does long term actually mean? Important research performed by Pu Shen, a senior economist at the Federal Reserve Bank of Kansas City, backs up the value of holding periods of at least 15-20 years. Shen found that after analyzing the results of stocks between 1926 and 2002, (a not-so-quiet period in our history), the real returns were always positive when the holding period was at least 19 years, which was not at all the case when it came to shorter-term results.
Based on the overall stock market’s consistent performance over the last century, the math shows you have the best chances of maximizing the value of your portfolio by keeping it invested for at least 25 years.
The question then becomes, how much of your total investment portfolio do you want to commit for 20+ years? You’ll be far more likely to stick it out if you allocate only a certain portion of your savings long term, and you’re more likely to be successful investing in smaller amounts consistently over those longer time periods. (Think: tortoise and hare). Unless, of course you can devote hours to researching every individual company and then accurately pinpoint when to buy low and sell high.
Beware of Quarterly Results
It’s very easy to be misled if you’re evaluating your portfolio’s results on a quarter-to-quarter basis. Again, this can create that false sense of urgency and prompt premature, knee-jerk decisions. Emotional investing destroys retirement dreams and costs inexperienced investors a ridiculous amount of money over their lifetimes. Even the pro’s get caught up in the game. Making drastic investment changes based exclusively off of quarterly results is a downright dangerous approach, and the inevitable outcome is that your risks will significantly increase.
Speaking of volatility
There’s no way of getting around the fact that investing has become more volatile and unpredictable and that motion can make you seasick and derail even the most solid plan. Diversification wins all battles, and ultimately, investing by its definition means you’re putting your skin in the game, and implies you’re going to have the patience and discipline to let those investments earn the greatest possible returns even with the up’s and down’s.