Long Term Investing

How to Survive and Prosper in the Stock Market Over the Long Haul

It’s easy to beat the market over the short term by taking unnecessary risks. This is what occurred during the financial crisis of 2007-2008. Most of the financial institutions and funds that went under were seeking higher returns than their markets historically provide. They used leverage to buy complex financial instruments to bump up their profits without understanding the risks involved in holding them in their portfolios. The investments eventually proved to be worth a fraction of what they were listed for on the balance sheet. This triggered margin calls as the debt to equity ratio ballooned which could not be met as credit markets dried up. The massively leveraged companies were used to going into further debt to meet cash obligations but when the credit spigot was turned off they had no other options but bankruptcy. Some were lucky enough to be bailed out by the US government or sell to rivals at distressed levels. Unfortunately for individual investors, the detrimental effects of these actions were not contained to the financial sector. They spread around the globe and precipitated a stock market crash and recession. Investors must learn to survive these hard times as they will repeat themselves in the future.

Long term investors must accept that they will lose money over multi year periods while invested in the stock market. They should plan for and fully expect market downturns. They will occur. There have been 11 bear markets in the past 70 years with the average downtown of 32%. We’ve seen the market fall 22% in a single day. Having fully accepted and planned for these bear markets will help individual investors act accordingly and not give in to panic selling during times of capitulation. Keeping some money in cash during good years is prudent and will provide a means to take advantage of discounted securities during bear markets.

Holding true to a diversified buy and hold plan through good times and bad will lead individual investors down a path of less stress and higher returns.  Unfortunately most investors do not have the patience to hold a long term portfolio and frequently get burned by trying to time the stock market.  Fortune Magazine reported that during the past 20 years the annualized 20 year average return of a mutual fund invest was just 1.9% while the stock market grew at 8% over the same period.