Warren Buffett once said that “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.”
However, there are only so many decades in our life.
Are you willing to spend, as Buffett suggested, 10 years holding stocks? Would it be worth your time?
Holding stocks for the long term has big rewards.
Pull out any long-term stock market index chart of at least 20 years or more, and it is often a straight line that starts from the lower left and rises to the upper right.
Take the US S&P 500 Stock Index for example, it has returned approximately 8% annualised gains over the last 70 years, turning US$100,000 into over US$21.9 million dollars.
Despite the evidence of huge returns over the long term, most people don’t hold stocks for the long term.
A recent analysis by Reuters using New York Stock Exchange (NYSE) data indicated that the average investor now holds stocks for less than 5.5 months.
This period is significantly shorter as compared to the three- to eight-year holding periods from the 1940s to the early 1980s.
The rise of instantaneous information flow, along with the convenience of electronic trading platforms, certainly do not help, making it easier for anyone to choose trading stocks over investing in them for the long term.
Trying to win a losing battle
The preference for trading stocks has a severe downside, because the odds weigh heavily against investors when their time horizon is shortened.
Consider the chart that was first shared with me by Motley Fool Co-Founder, Tom Gardner, more than seven years ago.
In a single day, your probability of winning in the stock market is roughly similar to a coin toss, about a 50-50 chance.
Extend that out to one year, and your chances increase to over two-thirds probability.
Stretch that to 10 years, and almost 90% of every 10-year period is positive.
Do it for 20 years and more, it is 100% positive, and you never lose any money.
That’s why getting the basics right is important.
Basics and fundamentals are important, just like the solid foundational pillars in building a house that can last.
Get the basics right, and you are more likely to do better.
Get it wrong, and you are more likely to struggle.
The question you should ask yourself is do you want to play a game where the odds of winning are in your favour right from the start, or one where the odds are heavily stacked against you?
Power laws drive the majority of long-term returns
For the adventurous among us, holding individual stocks can provide even better returns.
But there are caveats to note.
Hendrik Bessembinder’s 2020 study (“Long-Term Shareholder Returns: Evidence from 64,000 Global Stocks”) found that very few publicly listed companies accounted for the majority of global stock market returns.
The top 0.25% (160), 0.5% (319) and 1.0% (638) of stocks accounted for ~50%, ~64% and ~80% of returns. In other words, a small minority of stocks made up the significant majority of returns.
This phenomenon is referred to as the power law.
The implication for investors is that there is only a small handful of the best companies in the world that are worth investing in, that will generate the majority of long-term returns.
It follows that we need to find these winning companies, own them, and keep adding to them over the long haul.
Patience can be very rewarding
If you are patient, the payoff can be tremendous.
The maximum you can lose on a stock is 100%, thus the downside is limited.
Conversely, the maximum you can win on a stock is theoretically infinite, where multi-baggers can rise five times,10 times, 20 times, 50 times, and even 100 times or more.
The potential upside is, therefore, unlimited.
This very favourable asymmetric risk-return profile results in a very positive skew and power laws.
The few long-term large multi-bagger winners often account for the majority of returns, overwhelming all the losers.
Over time, these outsized winners will become more and more significant, and the losers will naturally become less and less relevant.
We too had similar observations from our own investment portfolio.
By allowing our winners to run, the accumulated gains from our top 10 and 20 winners (out of 84 positions as of 31 Dec 2021) accounted for 75% and 91% of our entire portfolio’s accumulated gains of almost five years.
Extending that to our 10 biggest winners, and the combined gains are more than 11 times all of the losses of all our losers combined.
On a return basis, we had 29 multi-baggers (~34% of the portfolio) whose gains are in excess of 100%.
The top three winners are more than ten times, seven times and five times on our invested capital thus far respectively.
Our personal experience adds evidence to the data that holding stocks for the long term works.
Expect volatility during the journey
Very often, one of the reasons why investors find it hard to hold for the long term is that the stock market can be very volatile in the short term.
In the short term, the market can go down faster than it goes up.
On average, the market falls roughly 10% every one year, 20% every four years, 30% every decade, and 40% or more every few decades.
More than 90% of the time, the stock market is trading off its previous historical high.
Price declines are absolutely normal. However, when and by how much, we don’t know in advance.
But, we should expect it, always.
Over the long-term, the market has shown that it goes up more than it goes down.
That’s why the long term is the only term that counts and matters, and that the rewards will be well worth your time.
Note: An earlier version of this article appeared in The Business Times.
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The writer is the Founder of Vision Capital, focused on long-term investing in global equities) and is also the author of the book “Vision Investing: How We Beat Wall Street & You Can, Too!”. He has vested interest in all the shares mentioned. Holdings are subject to change at any time.