Obits for Long-Term Investing Got the Story Wrong
by Chet Currier Dec. 2 (Bloomberg) -- Source Link Click here Long Term Investing decoded: - Under the long-tem investing method, you can prosper without calling every swing of the market pendulum - The big difficulty is, you have to keep faith through periods when the strategy appears to be doomed
It's time to correct some obituaries you may have seen in financial news forums a couple of years ago. The death notices were greatly exaggerated, it turns out, for Long-Term Investing, a cherished friend to millions of individual and family money managers. Old LTI, if we may speak familiarly of him, has plenty of admirers in the professional financial community as well. The mistake was easy to make. The patient gave a very sickly appearance after a 2 ½-year bear market in stocks that bottomed in October 2002. Even so, wise heads should have known better. As LTI has demonstrated over and over through his long and fruitful life, you never want to judge him hastily. He differs from the typical mortal creature in one very important respect: Time is on his side. Look what happened starting right around the moment when the loudest dirges were being played. From the end of September 2002 through November 2005, according to my Bloomberg, the Standard & Poor's 500 Index climbed at an annual rate of 16.5 percent, including dividends. The Nasdaq Composite Index rallied at an even faster 23.3 percent-a-year clip. Today, both of these broad market indicators remain well below their peaks. To get back to its former lofty heights, the Nasdaq -- which has doubled off the bottom -- will have to double again. Less Guesswork Ah, but LTI's fans never expect him to get them out at the top. They figure that kind of timing game is best left to sophisticated traders, only a minority of whom can ever hope to win at it. Since market tops come by definition at points of maximum buying demand, and market bottoms at points of a maximal urge to sell, logic dictates that a preponderance of in-and-outers will wind up buying high and selling low. That's a fate to be avoided at all costs. Under LTI's method, you can prosper without calling every swing of the market pendulum. The big difficulty is, you have to keep the faith through periods when the strategy appears to be doomed. As an aid to attaining the necessary patience, here are answers to a couple of frequently asked questions about Long- Term Investing: Defining Terms Q. Just how long is long-term, anyway? A. That's a tougher question than it may sound. The U.S. tax code says an investment held for one year and a day qualifies for long-term capital gains treatment. But whoever relied on the tax system for good sense? For financial planning purposes, a common rule of thumb uses five years as the line of demarcation. This too is open to debate. When I wrote a few weeks back about the poor five-year record of broad stock index funds, I heard from an accounting- firm partner who began: ``Come on, Chet -- five years is not long-term!'' In the absence of a definitive answer on this subject, we can formulate two principles, one theoretical and one practical. The first is that in any abstract discussion of Long Term Investing, ``long term'' is whatever time period is necessary to prove your argument or discredit your opponent's. The practical answer: What constitutes long term varies from one person to the next, depending on when each person's life-long objectives such as retirement or a child's college tuition fall due. What Now? Q. What is the outlook for Long-Term Investing from here on out? A. It is uncertain. This is what makes LTI such a challenging companion and guide. He isn't the simple, easy-to- get-along-with character so many suppose him to be. When you invest LTI's way, you aim at a target too distant for detailed analysis. Indeed, any time you rely upon something closer at hand to guide you, such as an earnings estimate for the next quarter or a market forecast for the coming year, you may deviate from the mission. LTI's approach rests on more than simple blind faith. We know from the historical record that economies tend to grow over time. Not always, just more often than not. We also know that LTI benefits from the potent force of compounding, whose power increases exponentially the longer you can keep it working in your behalf. While we can take much encouragement from LTI's long record of beneficence, we must always remember that he makes no promises about the future. Still, after you compare LTI with the available alternatives, who else are you going to trust?
