Warren Buffett once said, "our favorite holding period is forever." If you invested 100 dollars in the stock market in 1928 (one year before the great depression, when the stock market lost 90% of its value), it would be worth over $382,000 today. Of course, most people don’t live for 90 years, but it’s not to say you can’t pass on an investment to your children and their children. A more relevant example is this; you invest $1,000 at age 22 in 1978, and 40 years later in 2018 you turn 62 and decide to retire. Your original $1,000 investment grew to $75,000 by 2018, due to the growth in the stock market and reinvesting your dividends. This example shows you the power of Warren Buffett’s quote. This post is designed to show you that by staying the course for the long haul and developing a simple but strategic investment strategy, one day in the future you too may be shocked by the growth in your retirement and or investment accounts.
My thinking is this; with the knowledge of history (see chart to the right) and the belief the world is generally headed in the right direction, I believe the stock market will continue to perform at its historical average of 10% a year or 7% when you factor in inflation over the next several decades. With that logic, it’s always a good time to invest in the stock market and continue to invest throughout your life.
The key to this strategy is to be disciplined, and not take your eyes off the prize. Along the way, it is not unusual for the stock market to experience drops of 10, 20, or even 30% or more over a short period. The market will go up and down, and sometimes a recession will come like in 2008, however investors who choose to stick it out, have historically experienced a much higher rate of success than those who can't handle the psychology of having an unrealized loss for a short period of time.
The strategy in the introduction is this; by purchasing the ETF “SPY” from your online brokerage account, you are gaining exposure to most of the stock market. The ETF SPY tracks the performance of the S&P 500, which are the largest 500 companies in America. Napkin Note: If you purchased SPY in March of 2009, the ETF was trading around $67 per share, and at the time of writing this post it is about $280 per share, which is a 320% return on your investment. Investment strategies depend on one’s risk tolerance, age, investment timeline and goals; for example, are you seeking to earn income from your investments or grow your portfolio by reinvesting dividends?
Don’t Be A Timer
Investors are generally poor market timers, meaning they try to buy and sell at what they think is the most optimal time. The fact is they’re usually wrong and end up missing on high returns. We're all human, and we tend to be emotional, especially when it comes to investing. According to a Dalbar’s 2015 Quantitative Analysis of Investor Behavior study, over 20 years (1994 – 2014), the S&P 500 had an average annual return of roughly 10%, yet the average investor returned only 2.5% annually. Investors hurt their chances of success by market timing, which can be avoided by simply buying and holding for the long term.
Avoid the Noise
Throughout your life, you are going to come across some amazing or what you believe are amazing opportunities, some of which you will lose and some of which you will win. You need to understand when things sound too good to be true, they generally are. A recent example of this was Bitcoin. While I believe there is tremendous value in blockchain technology, I felt Bitcoin and others like it, were a classic example of a speculative bubble and as I watched my friends waste thousands of dollars on these digital coins, I believed the result would be a disaster. Many of those friends bought way too late in the cycle and lost most of their hard-earned money. Bitcoin ended up being a classic bubble, and many more will arise over our lifetimes. While you can make a lot of money in bubbles, I would recommend staying away from the “noise” and sticking with what has been proven to work over many generations. However, if you must, please keep this “bubble investing” to only 5% of your total assets. We want to invest in quality assets, and we should continue contributing as much as possible to quality investments and keep this “bubble investing” to a minimal.
Using ETF’s In Your Portfolio
When I invest in the stock market, I usually purchase Exchange Traded Funds (“ETFs”), which are diverse baskets of securities which can be purchased through an online brokerage firm. ETF’s are offered on almost all asset classes, ranging from stocks and bonds to currencies and commodities. When we invest in ETF's, we must review the expense ratio, which is what at you will pay every year to hold to ETF. This fee is separate from the brokerage commission, as the expense ratio fee goes towards the ETF provider. Generally, I would recommend purchasing ETF’s with an expense ratio of less than 1.0%, and in SPY's case, the expense ratio is 0.09%. If you invest $1000 in SPY, you will pay 0.90 cents a year in expenses.
On the right, you will find a table illustrating how even a small difference in the expense ratio can cost you thousands over many years. If you purchase ABC ETF with an expense ratio of 2.5% and XYZ ETF with an expense ratio of 0.5%, and we assume both funds grow at 7% a year, you would be missing out on $14,580 of gains or almost 38%, in just 20 years. This is incredible, so be sure you're investing in ETF's with expense ratios of less than 1.0%.
Taxes Favor the Long-Term Investor
If an investor buys and sells a stock within one year, the gains will be taxed as ordinary income (aka your federal income tax bracket), which can be as high as 37%. But if you hold an investment for over one year, your gains will be taxed at 0%, 15%, or 20% based on your current income level. These long-term taxes are called capital gains.
Leave your emotions at the door, follow the data, reinvest those dividends, and pay less in taxes. If you do those things, you will sleep better at night, and be able to think more clearly, even when a recession occurs. Let’s start a conversation, so please leave comments below.