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Define the Long-term When Investing in Stock Markets?
It is often said that you need to take a long-term view when investing in stock markets. But very few investors have any idea what, in fact, is the long-term! And many would-be investors are put off saving through the stock markets because they don't feel they can take the long-term view.
The first simple step to understanding what 'long-term' actually represents is to make the distinction between the person who is saving or investing regularly (and that includes the person with a pension) and the lump-sum investor.
The regular investor invests from cash flows, so that he/she is able to invest perhaps every month, every quarter or even annually. The key point is that they do not invest all of their savings or capital at one go but invest over time, and this has a significant bearing on what timeline one needs to take.
The lump-sum investor, on the other hand, already has capital from inheritance or the sale of a business or property. The lump-sum investor does not have the opportunity to add to that capital so that whatever monies he/she invests in risk assets they will not have an opportunity to add new monies in.
The Regular Investor - Defining the Long-term
Investing regularly makes it easy to iron out the volatility in markets. Here, you are investing when markets are high and low, when markets offer good value and when they are overvalued. Overtime, you get the average values and the average returns which have been circa 9% per annum over the past century in the developed markets.
We will now examine the plight of the investor who was unfortunate enough to have started investing $500 a month at the very start of either of the last two major bear markets, but who continued to invest for a five-year period. We will assume the investor bought a simple global equity ETF, in this case the iShares Global S&P 100 ETF (ticker code: IOO).
The chart above highlights the journey the investor went on from December 2000 to November 2005. Over this 5-year period, the investor made a gain of 15% (excluding dividend income). From the low of the bear market in August 2002, it took 13 months to get back to a breakeven position. From the start of his investment programme, it took two years and nine months to get back to breakeven.
The global credit crisis-driven bear market started in June 2006 so we will also look at how an investor fared from June 2006 to May 2011.
In this second 5-year period, the investor made a return of 10% (excluding dividend income). From the bottom of the bear market in March 2009, it took 22 months to get back to breakeven, and 3 years and 6 months from the start of the investment programme.
Hence, in two of the worst bear markets seen in the past 60 years, the regular investor was back to breakeven in under 4 years. As a result, it seems reasonable to conclude that 3-4 years represents the long-term for the investor who can add monies to his/her investment programme overtime.
The Lump-sum Investor
This investor is not in a position to add monies to his/her investment programme, and cannot take advantage of lower markets and the better values they offer.
Rather than asking: what is the long-term?, perhaps we could turn the question around and ask, 'what is the probability of my making a profit or loss on a 5-10 year view?' That surely is what it is all about - the probability of getting a positive return over various timelines.
The above chart highlights the rolling 10-year returns on the US stock market (including dividend income) from 1926 to 2011. The first return depicted is the 10-year period from 1926 to 1935. The next 10-year period is from 1927 to 1936, and so on.
The chart highlights that from 1926 to 2011, there were 77 ten-year rolling periods. Of those, only four 10-year rolling periods delivered a negative return, representing 5% of the time. The periods of negative returns coincided with times when the stock market was overvalued relative to history.
On a 5-year view the statistic works out at 15% i.e. there is a 15% chance of a negative return after five years. Again, the majority of the negative returns came after markets were overvalued relative to history.
For the lump-sum investor, it appears that, if markets are averagely valued, then a 5-10 year view is normally sufficient to ensure a positive outcome. In other words, 5 to 10 years can be considered to be the long-term for the lump-sum investor.
So long as you avoid the danger of a permanent loss of capital - which can occur if you buy poor quality businesses, businesses with too much debt or stocks that are overvalued - then investing for the long-term really means a 3-4 year period for the regular investor and a 5-10 year period for the lump-sum investor.
Follow the Regular Investor on the Website
On the GillenMarkets website, we invest €1,000 each month into a stock or fund from the list of researched and recommended stocks and funds available to subscribers. We monitor the progress of this portfolio, and you, the subscriber, are free to simply follow our selections or decide on your own. If you can save a few bob each month or even each quater, our Regular Investor slot on the website provides a real time guide on what to invest in. And we are there to provide guidance and support when markets are volatile and declining.