Last week, I talked about the importance of taking a long view when it comes to investing. This is the most fundamental component of my, and many others, investment philosophies. There are reasons that long-term investors are more confident and have a better outlook on their financial lives - time. As the saying goes, time heals all wounds, and that applies tenfold when it comes to the markets and investing.
As I said in last week’s blog, I am going to share what I’m calling the Grover Top 10 Principles of Long-Term Investing, OR The Keys to Investing Resilience, with you over the next few weeks. Over this time, I hope to show you many things about the benefits of taking a long-term approach, including the power of time. With that, let’s get started with the first three of the principles I’m going to share with you.
1. Understand what market movement really means.
While none of us will ever be able to predict the future, much less the markets, we do have history as our guide. And as it turns out, history is a rather good guide, and it helps us understand market movements and what they actually mean. History has shown us that markets are resilient and that while declines come, they do not last, no matter what you call them. Whether they be labeled a sell-off, a correction, or a bear market, history shows us that declines come and go, and while they can be uncomfortable, they are both inevitable and completely normal. Each time a temporary decline comes to town, history shows that time and again, the market not only recovers from what is ultimately a short-term decline in the grand scheme of things but goes on to post often record-breaking gains. Take the chart below, for example; it shows that in the past 42 years, only nine of the declines shown have resulted in a down year. Now those are odds I can get behind!
The point the chart illustrates that is even more important is this, if you move out of stocks during a temporary decline, you are potentially locking in losses that could prevent you from profiting from the inevitable and subsequent gains the markets will ultimately have.
2. Accept that volatility is both normal and healthy.
This brings me to the next of my keys to investing resilience, which is that volatility is not only normal and healthy but as my first point showed, it is also inevitable. Here’s the cold hard truth, markets are living things; they are always moving. They move up, they move down, they move all over - but what they never, ever do, is move in a straight line in a constantly upward direction. It just doesn’t happen, folks, I wish it did, but then I’d be out of a job. However, what they do with historical frequency is moving up continually over time with periods of short decline. This serves to illustrate my point that if you do sell when the market has one of its short declines, you could easily miss out when it picks up its upward march again, which history shows us it will. For example, the chart below shows us that, historically, bull markets have beaten bear markets and have driven long-term gains.
And the most important point this chart illustrates rather concretely is that having a disciplined and long-term approach can help you reach your financial goals.
3. You are your own worst enemy so avoid allowing your emotions to make investment decisions.
Staying with the word discipline for a moment longer brings me to the third point I want to make, which is simply that emotions and investing are two things that should never go together. In fact, putting them together is what makes humans their own worst enemies when it comes to investing. So, when you are making financial decisions, leave your emotions at home, and here’s why. When you compare the success of the average investor (Fig. 3) with that of the overall market as measured by the S&P 500 index, the average investor underperforms. The same is true when it comes to investing in bonds as shown in the chart below.
What I want to emphasize with this last illustration this week is that knowing your tolerance for risk is the key to avoiding emotional investment decision-making. We will talk more about this in the coming weeks, but I want to make sure this point is clear when we don’t understand how markets work, that volatility is normal and temporary, or what our long-term goals or risk tolerance is, we inevitably create a perfect storm of misinformation and emotionality. Therefore, long-term investing is the key - but long-term investing isn’t just a simple phrase; it is a series of attitudes and actions that we will get into in more detail starting next week when we discuss things like compounding and diversification.
Until next time…
One last thought, I believe an educated investor is an empowered investor. If you like what you’ve read and think your friends and family can benefit as well, please share.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested in directly.
All investing involves risk, including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Dollar-cost averaging involves continuous investment in securities regardless of fluctuation in the price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.