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The Basics of Long-Term Investing
Investing for a long-term goal like retirement doesn’t necessarily make you a long-term investor. Long-term investors share a similar strategy as they try to reach their goals.
Are you a long-term investor? Two simple questions can help you find out if you’ve got the mind-set to buy and hold.
- Do you believe you can time the market — buy when prices are low and sell when prices are high?
- When the market starts to decline, do you sell your investments to try to lock in gains?
If you answered “yes” to either question, you’re probably NOT a long-term investor.
The buy-and-hold mindset. Long-term investors are known for their buy-and-hold strategies. They choose investments carefully and believe they’ll be rewarded for holding them over the long term.
Long-term investors tend to pay less attention to short-term performance. They hold their investments through market ups and downs because the market has generally rewarded that strategy in the past. Past performance, however, doesn’t guarantee future results.
Patience Has Been Rewarded
The graph below shows the general upward trend of the market over the past 25 years (based on the S&P 500 Index). Buy-and-hold investors have benefited from this trend, and they believe it will likely continue.
Of course, you can also see some significant market declines in the graph. Buy-and-hold investors accept short-term declines and believe the best course of action is to hold on, even during extended bear markets.
The Patience of Long-Term Investors
Has Been Rewarded
S&P 500 Index 1986–2011
Source: © 2012 Morningstar. Shows performance of the S&P 500 Index for the 25 years ended 12/31/2011, with a hypothetical starting value of $10,000, including the reinvestment of dividends. Indexes are unmanaged and unavailable for direct investment. Past performance does not guarantee future results. Not intended to represent or predict the performance of any Franklin Templeton fund.
Buy-and-hold investors avoid market timing. The opposite of a buy-and-hold strategy — trying to predict short-term market movements and moving in and out of investments accordingly — is called market timing. Long-term investors believe staying invested is a better strategy than trying to predict the market. “Time in” the market, as opposed to “timing” the market.
For the sake of argument, however, let’s say you could predict the market with 100% accuracy and you invested $10,000 on the best day to invest — the market low — every year for the last 25 years. Your average annual return would have been 6.89% through December 31, 2011.
Compare that to someone with terrible timing who invested $1,000 at the market high every year for the last 25 years. The average annual return would have been 5.02%.
Is Market Timing Worth the Time?
Average Annual Returns S&P 500 Index 1986–2011
Source: © 2012 Morningstar. Shows average annual returns for a series of hypothetical $10,000 investments in the stock market, as represented by the S&P 500 Index, made on the best day and worst day each year 1/1/86–12/31/11. Based on price changes only and doesn’t include reinvested dividends. Indexes are unmanaged and unavailable for direct investment.
The best day average annual returns aren’t astronomically better than the worst. The small difference between the absolute best and worst explains why buy-and-hold investors don’t bother with market timing. They know that being in the market is more important than exactly when they get in or out.
Of course, it would be a real long shot to pick the best day to invest each year for 25 years in a row. Choosing the worst day is just as unlikely. But as market timers move in and out of the market, looking for signs that might point to the exact right time to buy or sell, it’s possible they could miss a few of the market’s best performing days.
Long-term investors always catch the market’s best performing days because they stay invested over the long haul. Missing just a few key days in the stock market can have a dramatic effect on overall portfolio results.
|Period of Investment||S&P 500 Average Annual Total Return|
|Source: Standard & Poor’s Corporation. The market is represented by the unmanaged Standard & Poor’s 500 Index and includes reinvested dividends. One cannot invest directly in an index. Past performance does not guarantee future results.|
|Remained Fully Invested||7.81%|
|Missed the 10 Best Days||4.14%|
|Missed the 20 Best Days||1.70%|
|Missed the 30 Best Days||-0.39%|
|Missed the 40 Best Days||-2.31%|
Buy-and-hold Investors Evaluate Regularly
Don’t get the idea that long-term investors ignore their investments. No one should do that. Typically, long-term investors will meet with their financial advisor about once a year to evaluate their financial plan, investments, and progress toward their goals.
If any particular investment is no longer in line with the investor’s time frame or if the risk level is making the investor uncomfortable, it may be time to sell all or part of some holdings.
The buy-and-hold strategy of the long-term investor requires the patience to wait out a bear market. Although past performance doesn’t guarantee future results, the long-term investment strategy has historically brought financial rewards to many investors.
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