Investing in stocks can be rewarding — that is, if you are willing to hold them for the long term.
But just how good can your returns be?
According to JP Morgan (NYSE: JPM), from 1950 to 2023, the S&P 500 (INDEXSP: .INX) delivered an annual average total return of 11.4 per cent per year.
To put that in dollar terms, US$100,000 invested would increase to a little under US$870,000 in 20 years.
Right, but what if you invested in bonds instead?
Over the same period above, bonds would produce a decent 5.3 per cent per annum in returns, but it’s less than half of what stocks can offer.
Here’s the kicker: with compounding, the gap between stocks and bonds grows even wider.
For every US$100,000 you put into bonds, your investment would grow to around US$280,000 in two decades, or less than a third of your stock returns over the same period.
The key difference? The holding period.
Compounding: don’t interrupt unnecessarily
The late Charlie Munger once said that the first rule of compounding is to never interrupt it unnecessarily.
Again, JP Morgan’s statistics illustrate his point.
Let’s look at the S&P 500’s performance between May 2004 and May 2024, a 20-year period which produced an average annual return of 10.2 per cent per year.
Here’s the shocker: If you missed the market’s 10 best days, your double-digit gains will shrink to only 6 per cent per year. And if you miss the top 20 days? Your returns will plummet to mere 3.3 per cent per annum, barely keeping up with inflation.
Don’t bet on timing your entry either.
During this period, seven of the 10 best days occurred within 15 days of the 10 worst days. In other words, unless you can day-trade with precision multiple times in a row, you are better off just holding your stocks through the volatility.
Ask yourself, have you ever met someone who has consistently pulled that off? I know I haven’t.
Here’s another thing: history has shown that the longer you hold, the better your chances of producing a positive return. From 1980 and 2023, the S&P 500 delivered positive returns in 33 out of the 43 years.
For the math geeks, that’s a win rate of over 76 per cent, far better than a coin flip.
To top it off, there hasn’t been a single 20-year period since 1950 where the stock market has seen negative returns.
Now, that’s the kind of odds you want on your side.
More than just buy and hold
While compounding is powerful, blindly buying any stock isn’t the answer. Many are not worthy to be held over long periods.
Quality is the key.
For a stock to compound, you need its underlying business to be built to last.
You can start by looking for companies with a strong track record of profitable growth which are financially self-sufficient. From there, you need to figure out what it has done well, and whether it can continue to do well in the future.
If you can do that, you will have a higher chance of uncovering a winning stock.
That said, there’s a hard truth to swallow: there is no exact formula which says a stock will do well in the future. There are simply too many variables which cannot be predicted ahead of time.
So, what is an investor to do?
Here’s what is less discussed: Holding a stock for the long run does not mean you sit around and do nothing. In my eyes, the greatest advantage long-term investors have is the accumulated knowledge of the businesses they study.
Why is that so?
In a world short of attention, I think that investors who follow a business closely for long periods of time will outlast even the best analysts out there.
Even the brightest minds out there have limitations when it comes to giving attention to a stock.
So, if you can do the ordinary, that is to pay attention and be patient, you can come out ahead of many other investors who are distracted by the latest trends or happenings.
Patience is under-rated
Today, we live in a world with an endless flow of information, each demanding our attention.
Every new piece of information in the stock market is dressed up to sound more important. This flood of data often draws a response, causing investors to buy or sell stocks based on the latest news.
Many times, investors feel pressured to act.
Yet, if you adopt the mindset of the long-term investor, you should be in no hurry to take action. Instead, you would want to take your time to sort out the important business development from the frivolous information.
Never feel pressured to make a decision amid the insistent drone of the financial media.
But how can you avoid falling prey to the noise?
For starters, take your time to invest, start small if you have to. That way, you won’t feel pressured to act at any time. As my investing friend Tom Engle used to say, if a stock turns out to be a winner, a little is all you need. If it is not, then a little is all you want.
Here’s the thing investors should remember.
A stock takes time to compound. It won’t happen overnight. As Peter Lynch, the former manager of the Magellan Fund, used to say, the best stocks are those which he has owned for five years or more.
So, take your time.
Take heart that if a stock is destined to be a winner, you will have plenty of time to add to it.
Get Smart: You either win or you learn
So, what if you are wrong in your assessment of a business?
And what if you hold a stock for the long term only to have it underperform?
Like any investment approach, there are no guarantees.
However, I submit to you that the lessons you learn holding a stock for the long term will far outweigh any other lessons you pick up from the stock market.
Each stock, whether it turns out to be a winner or a loser, will provide invaluable lessons you can apply in the future.
In time, as you learn more over time, you’ll get better and better in picking the right stocks to hold.
After all, as the late Nelson Mandela once said, I never lose, I either win or I learn. We should adopt the same mindset when it comes to investing.
Note: An earlier version of this article appeared in The Business Times.
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Disclosure: Chin Hui Leong does not own any of the stocks mentioned.
