Tips For Successful Long Term Investing

A Guide for Long-Term Investing

Some newcomers to share market investing begin with one thought in mind – find a stock that will return a profit. With a deeper understanding of how markets work, these newcomers realize they need to have a framework for how much profit they are willing to accept and how long they are willing to wait to achieve it.

The framework is the foundation for long-term investing strategies versus short-term investing strategies. In long-term investing, investors enter an investment expecting to hold the stock for the conventional wisdom period of five years or more, accepting jumps and falls in profit along the way.

In short-term investing more commonly associated with traders, the holding period could be as little as a day provided the stock jumps up to an acceptable level of profit, and rarely more than a year.

Think Long-Term

Long-term investments have lower fees and tax burdens than short-term investments requiring more trading with associated fees, higher taxes, and no compounding advantage. However, research conducted by global investment firm Vanguard found a better reason to adopt long-term investing. Investors who stayed in the market for 10 years saw average annual returns of 7.1%. In contrast, the study found short-term trading results varied greatly between substantial swings between outperformance and underperformance.

Long-term investing benefits from compounding, especially with dividend paying stocks while short-term gains do not have the time for returns to build on themselves.

Diversify

The holding period for long-term investing varies across market experts, from more than one year to five years or more. When legendary US investor Warren Buffet was asked what his holding period was, he replied “forever!” Regardless of the period, longer time frames reduce risks associated with market upward and downward movements.

Many market experts strongly advise to develop a detailed investment thesis  detailing their reasons for investing in a stock. The holding period then remains in effect until the investment thesis substantially changes.

Diversification is another strategy to reduce risk in long-term investing. Australian investors who prefer to keep their money at home are at a slight disadvantage due to the domination of the financial and materials sectors on the ASX 200.

Home grown investors can diversify their portfolios outside of Australia through the extensive range of ETF (exchange traded funds) with exposure to global market and business sector outside Australia.

For exposure to US markets, Aussie investors can choose from the following:

• iShares S&P 500 ETF (ASX: IVV)
• VanEck Morningstar Wide Moat ETF (ASX: MOAT)
• Betashares Global Quality Leaders ETF (ASX: QLTY)

ETFs trade like stocks, allowing investors to apply the same holding period standards they apply to other investments in their portfolio, although the investment thesis will lack the specificity of an individual stock.

Stick to the Plan

Life is full of plans, put together with painstaking effort and then placed in a desk drawer, rarely if ever to see the light of day again.

That is not a strategy for successful long-term investing. Traders can live with a “get in, get out” strategy but long-term investors need a long-term strategy.

Traders are more prone to following hot tips and the signal/noise ratio typical of much of the financial reporting of the day. Some of what an investor reads is “signal,” meaning it has a bearing on the investment thesis of one or more stocks in their portfolio. However, much of the information bandied about is irrelevant. The short-term strategic investor is more likely to follow the herd, with “quick profit” representing the sum and substance of their investment thesis.

A long-term investing strategy grounds stock investments in their future potential, not their past performance nor the swings in market movements that can at times be highly volatile.

Long-term strategies fit a range of investor temperaments, with some leaning towards a contrarian approach running against the market herd mentality.

Growth strategies focus on stocks with business models in sectors poised for high growth potential.

Income investing strategies look for high quality dividend paying stocks with outstanding dividend performance over time and low payout ratios.

Value investing strategies suit bargain hunting investors, focusing on stocks market participants are underestimating.

Regardless of strategy, successful long-term investors stick with their plan.

Cut Losses and Hold onto Winners

In 1912 George Selden wrote “Psychology of the Stock Market.” The book introduced a new field in stock market investing – the study of psychological factors that influence the behavior of investors, — Behavioural Finance.

The concept of loss aversion is perhaps the greatest contribution Behavioural Finance made to investing. Loss aversion finds that the emotional pain an investor experiences from a losing trade is greater than the emotional pleasure experienced from an equivalent winning trade.

In practice, this means investors are overly concerned with their losing stocks. A consequence is the behavior of hanging on to losers in hopes the trade will eventually turn positive. For a variety of reasons, many retail investors will take gains from winning stocks in lieu of dumping the losers. Successful long-term investors cut their losers and stick with their winners.

Focus on the Future

Investors read the disclaimer that past performance is no guarantee of future potential at the conclusion of virtually every article highlighting the stock in the financial news.

Successful long-term investors are not obsessed with popular valuation ratios based on market price. With one exception, these ratios are backward looking. Only the P/EG – price to earnings growth – ratio includes estimates of future growth in their calculation.

While infinitely superior to the classic Price to Earnings (P/E), Price to Sales (P/S), and Price to Book (P/B) ratios that are all backward focused, the P/EG has limitations. The potential growth used is an estimate which may or may not happen. In addition, few financial websites or trading platforms that include the P/EG identify the source or the growth estimate.

Beware of Penny Stocks

Penny stocks can be like the sirens of ancient Greek mythology – half-bird, half-woman creatures that lured sailors to their demise. Penny stocks are cheap enough to allow investors to buy huge quantities, allowing investors the pride of owning a million shares of something.

Even the penny stocks subject to the regulatory requirements of a major stock exchange like the ASX suffer from one often a fatal flaw — lack of information. Pennies rarely attract professional financial analyst coverage and the interest of financial websites in  publishing news about publicly traded companies.

Retail investors often fall into two camps – short-term traders and long-term investors. While both have profit as the ultimate goal, the trader looks for investments with the potential to turn profitable quickly, often in less than a year and sometimes in less than one  month or even one day.

Long-term investors prefer to hold onto what they buy, usually for at least five years and longer in some cases. The extended time frame smooths out the volatility of market upward and downward movements. Short-termers trade more, amassing more trading fees, and pay higher taxes on stock sales than long-term holders.