Time horizon is something you don’t often hear investors talk about.
The truth is everyone has a different definition of what constitutes short-term and long-term.
For traders who react to minute-by-minute price movements, a week may seem long.
But for an investor who is parking his money in stable, blue-chip stocks, months or even years is a reasonable time horizon.
So, let’s drill down into an important investment tenet that will stand the test of time – investing for the long term.
We offer several reasons why you should do so rather than focus on the short-term volatility of the stock market.
Ignore the emotional roller-coaster
Short-term price movements are affected by all manner of news flow and events.
Anything from macroeconomic announcements, corporate and business updates, or industry news may have an impact on a company’s share price.
Oftentimes, sentiment also plays a key role in determining how much investors are willing to pay for a stock.
These myriad factors muddy the waters when it comes to understanding how a company obtains its value.
The fundamental reason why investors should pay more for a business is because it can generate higher profits, cash flows, or dividends.
The rest of the factors are simply noise.
Hence, possessing a long-term mindset can help you to better ignore the cacophony of voices urging you to constantly buy or sell your stocks.
A sapling into a tree
Everyone knows that it takes time for a seed to germinate into a seedling.
It takes even more time for the seedling to sprout, mature, and grow into a sturdy tree.
But when it comes to the stock market, many investors are impatient and expect companies to deliver results in double quick time.
Blame it on our culture of instant gratification, but good things do require time and patience.
The same can be said for strong businesses.
Time is needed for a company to evolve and grow into a larger one.
Plans need to be made, factories built, and products manufactured.
Even companies that are acquisitive need time to buy other businesses, integrate them, and extract synergies.
Investors, therefore, need to have the time and patience to wait for a business to flourish.
Remember the wise words of Warren Buffett, a well-known investor with a stellar track record.
He says that “if a business does well, the stock eventually follows”.
The key word here is “eventually”.
We won’t know when the share price will catch up with the business, but we do know that it should eventually happen because investors will want to pay more for a stronger business.
Thus, patience is an important attribute for an investor to have, which explains the focus on long-term investing.
Management’s quality
Management may not always make optimal choices for the business.
Being human, there are inevitable stumbles as mistakes are made.
The key is to observe how management reacts to these errors and whether they take steps to learn and recover from them.
The passage of time can help you to better understand how management handles various crises such as economic downturns or competitive threats.
You can then judge if the management has what it takes to steer the company successfully through these challenges.
It’s also important that management is candid and open to admitting their mistakes, and takes concrete steps to rectify them.
Investors should also ensure that mistakes are learnt and not repeated in the future.
The power of compounding
As companies grow and generate profits, they reinvest a part of these profits to generate further growth.
This process is known as compounding and is what makes strong companies even stronger over time.
You can do the same, too, with your portfolio.
By focusing on the long term, you can achieve compounding across your portfolio to better prepare yourself for retirement.
The process is simple but not easy.
You start by buying solid dividend-paying stocks such as DBS Group (SGX: D05) or Keppel Ltd (SGX: BN4).
You may also consider blue-chip REITs such as Mapletree Logistics Trust (SGX: M44U) or Frasers Centrepoint Trust (SGX: J69U).
As you accumulate these stocks, they will start paying out dividends either on a half-yearly or quarterly basis.
As these dividends pile up, you have the option of reinvesting them into the same companies that paid them out.
Similar to how companies reinvest their earnings, you can reinvest your dividends to generate even higher dividends over time.
As your dividend stream grows, you can then enjoy more passive income that can supplement your active income.
Eventually, when your passive income becomes higher than your expenses, you would have achieved financial freedom.
This process sounds attractive but remember that it requires not just patience but sufficient time before the compounding makes a difference in your life.
By maintaining a long-term investment horizon, you can realise the many benefits stated above and end up with a much larger portfolio and dividend stream.
If you’re nervous, confused, or worried about buying your first stock, then our latest beginner’s guide to investing can help. It’s easy to read yet packed with valuable insights. Download it for free today, and buy your first stock in the next few hours. Click here to get started.
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Disclosure: Royston Yang owns shares of DBS Group.
