That poor 10-year stretch put a big dent in the boilerplate stay-the-course personal finance advice that Wall Street has been doling out for decades. But maybe, just maybe, most investors' concept of what the long term really means is, well, a tad shortsighted. Performance statistics going back 60 years suggest that holding stocks for 20 years — yes, 20 years — may be what it really takes to ride out the market's ups and downs, smooth out returns and make a buy-and-hold investment pay off .
Historical data compiled by Oppenheimer show that stocks have not suffered an average annualized loss in a 20-year holding period (measured in rolling monthly periods) since 1950. That's not the case for buy-and-hold periods lasting 10 years or less.
This is stocks for the really, really long run.
"Historical evidence suggests that longer investment horizons typically produce better results," says Oppenheimer's chief investment strategist Brian Belski.
Belski's data show that while average annual returns since 1950 are quite similar regardless of how long you hold your stocks, the range of returns differs markedly. Short-term holding periods are far more volatile. In short, it's easier to hit home runs if you hold your stocks for, say, one year. But you also risk losing your shirt if the market tanks. In contrast, returns are smoothed out over longer periods.
The biggest annual gain with a one-year holding period is a plump 53.4%. The worst: a stomach-wrenching drop of 44.8%.
In contrast, the maximum average one-year return is 14.4% when holding on for 20 years. But even the minimum average annual performance is positive, a 2.4% gain.
And this 60-year period included all sorts of scary things. The mid-'70s recession and OPEC oil embargo. The 1987 stock market crash. The 1998 Asian financial crisis. The bursting of the tech-stock bubble in 2000. And the just-concluded Great Recession.
"The lesson here is: Chill, stay invested, stay disciplined and be diversified," Belski says.
Timing is everything
Sure, you can try to time the market. You might get lucky once in a while and make a killing by buying into booms and getting out at or near a market top. Or, conversely, stay on the sidelines in down markets then put a big pile of free cash to work at the bottom of scary bear markets and ride the wave back up. But the likelihood of an investor getting in and out of the stock market at just the right time is a low-probability event, studies have shown.
Most investors don't grab all the gains the market or their stock mutual funds earn because they jump in and out of the market at the wrong times, due largely to emotional decisions driven by fear and greed, says Louis Harvey, president of Dalbar.
In the most recent 20-year period, due to poor market timing, stock investors earned 3.8% a year, nearly 5 percentage points less than the broad market, as measured by the Standard & Poor's 500-stock index, which returned 9.1% on average, a recent Dalbar study found. The average holding period for a mutual fund was 3.27 years in 2010, Dalbar says.
Much of individual investors' lagging performance is blamed on psychological factors. More often than not, they buy high and sell low rather than the classic winning strategy of buy low and sell high. Put another way, they sell the dips, rather than buy the dips.
"Fear," says Harvey, often prompts investors to bail out of stocks after prices have fallen far and the worst of the decline is over. They make matters worse "by delaying getting back in" early enough to participate in the eventual recovery.
"They abandon their plan instead of sticking to it, even though we have history going back 100 years that shows the stock market does recover," Harvey says.
By getting out of stocks, investors end up missing out on big rallies. If you missed out on the 10 best days between 1980 and 2010, your average annual return would have dropped to 5.7% from 8.2%, according to Oppenheimer's report.
There is a caveat: Just as missing the big up days hurts performance, being out of the market on big down days boosts performance, says Fran Kinniry, principal of Vanguard's Investment Strategy Group.
Recouping losses
Despite the scary nature of the last financial crisis, which knocked the stock market down almost 57%, some 91% of 401(k) investors who had account balances during the 2007-09 bear market now have more money in their accounts than they did at the market peak in October 2007, a recent study by the Employee Benefit Research Institute found. In that time the stock market has almost doubled in value.
And stocks have also outperformed bonds — the current investment of choice for risk-averse investors — nearly 100% of the time over 20-year periods since 1871, a Vanguard study found.
A key reason why investors who stay the course end up doing well is the fact that stocks go up roughly two-thirds of the time.
"The longer you stay invested, the greater the chances you will capture the market's uptrend," Harvey says. "When you deal with shorter snapshots, it is like potluck if you will be a winner or a loser. Ten years, in my view, is too short a period to optimize returns and take advantage of the market's long cycles."
But there is a catch, says Vanguard's Kinniry: "You have to make sure your holding period matches the period you are willing to hold."
For most Americans, "A 20-year holding period is unrealistic," says Mark Lamkin, CEO of Lamkin Wealth Management and author of Millionaire's Roadmap. "At some point, most people will need income or have to sell their stocks to raise money. And in the depths of a crisis, even the most staunch buy-and-holders" sell in fear.
Lamkin says long holding periods make the most sense for investors in their 20s and 30s. Investors in for the long haul should buy diversified funds to avoid the risk of a single stock falling to zero.
The key to staying invested for long periods is to stick to your plan through good times and bad, Belski says. He says owning stocks that pay dividends that are constantly growing is a wise strategy, because dividends will provide downside protection and keep you from fleeing the market when things get tough.
Harvey says it's easier to stay invested if you only have money in the stock market that is targeted at long-term goals. Don't put cash at risk in stocks if you need it for a down payment on a house in a year or two. If you have a mix of 50% stocks, 25% bonds and 25% cash, stick to it. Rebalance your portfolio once a year to make sure those percentages don't get too out of whack and to avoid changing your risk profile, Kinniry adds.
Buy on sale
Jeremy Siegel, a professor at The Wharton School and author of Stocks for the Long Run, says you will greatly improve your chances of posting gains over a 20-year period if you buy the bulk of your stocks when they are selling cheaply. It's not wise to buy stocks when they are superexpensive, such as when they were selling at more than 30 times their earnings back in the highflying '90s.
Your odds of making money are better if you buy when valuations are below average, like now. The S&P 500 is trading at 13 times this year's earnings, below the long-term average of 15. "I think the market is a buy here," says Siegel.
Winning strategies include dollar-cost averaging, which entails buying stocks on a regular basis, allowing you to buy more shares when they are cheap and fewer when they are pricey. Investors who deploy their cash only during "end-of-the-world scenarios" also tend to do well, Siegel says.
"The psychology of human beings works against staying in the market," Siegel says. To stay in the market for long periods, "You have to have blood like ice water."
Source http://www.usatoday.com/
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