Principles for successful long-term investing
Principles for successful long-term investing
The key to successful investing isn’t predicting the future, it’s learning from the past and understanding the present. In Principles, we present seven time-tested strategies for guiding investors and their portfolios through challenging markets and toward tomorrow's goals.
Learn the seven principles for successful long-term investing
1. Plan on living a long time
LEFT: We are living longer
Thanks to advances in medicine and healthier lifestyles, people who are 65 today have a very good chance of reaching ages 80 or 90. A 65-year-old couple might be surprised to learn that at least one of them has a 48% probability of living another 25 years and needing investments to last until age 90.
RIGHT: Many of us have not saved enough
Studies reveal that individuals do not feel adequately prepared for retirement. Investors should start early by saving more, investing with discipline and having a plan for their future.
2. Cash isn't always king
TOP: Cash pays less
Investors often think of cash as a safe haven during volatile times, or even as a source of income. But the ongoing era of ultra-low interest rates has depressed the yields on most cash instruments to near-zero -- well below the rate of inflation. With rates expected to rise slowly as the Federal Reserve gradually normalizes monetary policy, investors should be sure an allocation to cash does not undermine their long-term investment objectives.
BOTTOM: There is a lot of it
More than $12 trillion of cash -- roughly two-thirds the size of the U.S. GDP -- still sits on the "sidelines," earning next to nothing and largely missing out on a truly historic bull market.
3. Harness the power of dividends and compounding
TOP: The power of dividends and compounding
In this simple illustration, an initial investment of $10,000 in the S&P 500 price return index would have grown to over $200,000 since 1970. But if dividend payments were included, reinvested and allowed to compound over time, that same $10,000 investment would be worth more than $1,000,000 today.
BOTTOM: Investing in risk assets is critical
Many investors shy away from the stock market, unwilling to take on added risk. But this chart shows a staggering difference in the value of $10,000 invested in a variety of different asset classes over time, ranging from low-risk T-bills to U.S. small cap stocks.
4. Avoid emotional biases by sticking to a plan
TOP: In good times and bad, stick to a plan
Some investors lament the fact that a diversified portfolio has failed to keep up with the raging bull market since 2009. This is only half of the story! As the chart shows, a portfolio that included bonds saw reduced losses during the financial crisis, enabling these diversified portfolios to recover much faster than a portfolio of stocks alone.
BOTTOM: The heavy cost of market timing
This chart is based on the famous Dalbar study titled "Quantitative Analysis of Investor Behavior." This study estimates that over the last 20 years, the average investor has achieved a scant 2.1% annualized return as compared to more than 7% in 60/40 stock/bond portfolio, thanks in part to badly timed (and often emotionally driven) investment decisions.
4. Avoid emotional biases by sticking to a plan (PART 2)
LEFT: Home-country bias
While the United States still boasts the single largest economy in the world, it accounts for only a small fraction of global GDP and just over 35% of the world’s capital markets. Yet, statistics show that U.S. investors have nearly 75% of their investments in U.S.-based assets.
RIGHT: Familiarity bias and concentrated positions
Our investment biases show up in other ways too. Where we live, and even our field of expertise, can influence the way we allocate our assets. It is important that investors are aware of these biases and employ a disciplined investment plan that can help minimize their influence.
5. Volatility is normal; don’t let it derail you
Seeing through the noise
Every year has its rough patches. The red dots on this chart represent the maximum intra-year decline in every calendar year for the S&P 500, since 1980. While these pull-backs can't be predicted, they can be expected; after all, markets suffered double-digit declines in 20 of the last 36 years.
But despite the many pull-backs, roughly 75% of those years ended with positive returns, as reflected by the gray bars. Investors need a plan for riding out volatile periods instead of reacting emotionally.
5. Volatility is normal; don’t let it derail you (PART 2)
Even balanced portfolios can drift when markets fluctuate
Markets swing between highs and lows, but if a diversified portfolio is regularly rebalanced, it doesn’t have to follow suit. A buy-and-hold strategy that doesn’t include annual rebalancing can lead the best-performing asset class to dominate the portfolio, often just before a downturn, when balance and diversification are most important. Regular rebalancing helps investors stay in control, and has historically generated more return for the risk taken, compared to buy-and-hold alone.
6. Staying invested matters
It’s always darkest just before dawn
Market timing can be a dangerous habit. Sometimes, investors think they can outsmart the market; other times, fear and greed push them to make emotional, rather than logical, decisions.
From our Guide to Retirement, this chart is a sobering reminder of the potential costs of market timing. By missing some of the market’s best days, investors can lose out on critical opportunities to grow their portfolio, with devastating results. Importantly, as the slide also notes, “Six of the 10 best days occurred within two weeks of the 10 worst days.”
6. Staying invested matters (PART 2)
Good things come to those who wait
While markets can always have a bad day, week, month or even year, history suggests investors are less likely to suffer losses over longer periods.
This chart illustrates the concept. While one-year stock returns have varied widely since 1950 (+47% to -39%), a blend of stocks and bonds has not suffered a negative return over any five-year rolling period in the past 66 years.
7. Diversification works
Diversification has served its purpose
The last 15 years have provided a volatile and tumultuous ride for investors, with multiple natural disasters, numerous geopolitical conflicts and two major market downturns.
Yet despite these difficulties, cash was among the worst performing asset classes shown here. Meanwhile, a well-diversified portfolio of stocks, bonds and other uncorrelated asset classes returned nearly 7.0% per year over this time period (and over 150% on a cumulative total return basis).