The Long-Term Investing Method
The odds of beating the market are slim-to-none. Some say 2–3% while some might say 18–20%. These numbers mostly refer to day traders and swing traders who seek home-run trades in short spans of time. If beating the stock market and getting rich was as simple as placing one trade or two, everyone would be doing it.
When it comes to investing, common phrases like, “Be in it for the long-haul,” or “You’ll need a diversified portfolio,” are commonly referred to for good reason. It is proven advice that can earn investors serious money when it comes time to cash out.
Uncertainty from Recent History
Looking back on the last fifteen years or so, some major events have occurred.
- The Dot-com Bubble
- Y2K panic
- Terrorist attacks on 9/11
- Wars in Iraq and Afghanistan
- Tsunamis in Indonesia and Japan
- The Great Recession
- Obama becoming the first African-American President
- The 2016 Presidential Election
Not knowing the economic impact of major national and international events, investors always feel uncertain to some degree about their financial security. The best solution for needing to overcome future economic uncertainty, is to establish a simple long-term method. It can be as simple as being patient and diversified.
Patience is an important trait that great investors possess. Patience is simply getting through a period of time without getting angry or upset. A long-term investor will go through periods of wanting to pull their money from their investments when markets dip. The ones who remain patient and don’t pull their money out, are the ones who watch their investments grow when markets rally.
When using Bankrate’s Investment Calculator to look at an average 401K plan, it is easy to see how over the long-term, small contributions add up, even through tough times. However, it is worth noting that not all plans are equal and so it is good practice to rebalance long-term portfolios about once a year. Rebalancing takes minimal effort and time, but these small tweaks can net thousands of extra dollars over the life of the portfolio.
In order to achieve the average rate of return of 7%, one must diversify to account for market fluctuations. This can be part of the initial investment strategy and when it comes time to rebalance the portfolio.
Diversification is simply mixing different investment types within a portfolio. Investment types include stocks, bonds, cash, and commodities. They all react differently from one another when major events occur. Some have a positive relationship with one another while others may have a negative relationship. The goal is to prevent all investments from plummeting all at once and from totally wiping out any previous gains.
To test the importance of diversification, here are three examples comparing a low risk investment to a high risk investment through a 15–20 year timeframe.
Example #1: Stocks vs. Gold
The chart below shows two different recessions occurring, the Dot-com Bubble of 2000 and the Great Recession of 2008. It displays how stocks plummeted when the recessions hit, while gold remained strong and even grew. Most recently, the economy has become stronger and investors are investing more in stocks than in gold.
(S&P500 = green mountains and Gold = yellow line)
Example #2: U.S. Dollar vs. Gold
The U.S. Dollar became weak throughout the years after the Dot-com Bubble and throughout the Great Recession recovery period. Thanks to a stronger economy today and Brexit, the U.S. Dollar has become stronger causing gold to fall back down. The smaller gap between the two investments today compared to 2011, show that there is some stability in the U.S. economy.
(U.S. Dollar = green mountain and Gold = yellow line)
Example #3: 20 Year Bond vs. S&P500
Bonds have been popular over the last fifteen years because of economic uncertainty. When the recessions hit and stocks fell, investors turned to bonds for safety. 2009 was a great example of how stocks and bonds acted differently from one another. Today, as confidence rises within the economy, people are turning more to stocks than bonds. They do have one of the more different relationships because interest rate levels determine how they interact with one another.
(iShares Barclays 20+ Yr Treas.Bond (ETF) = green mountain and S&P 500 = red line)
The takeaway here is to show that as one investment goes up, another may go down. At points they may go up together, or go down together. As history has proven, there will be recessions roughly every six years, lasting about one year each. In relation to a thirty-year period or longer, they will have little impact on the end result as long as investments are diversified.
In summary, the earlier one invests, the better off they will be over the life of a long-term portfolio. Any good investor shall remain patient, in tune with their portfolio, and make sure all investments are diversified. If an investor abides by this simple advice, a small nest egg can lead to a worry-free future and financial security.
-Eric Barden, Marketing Manager
Originally published at technicianapp.com on August 5, 2016.