Personally I am very much into long term investing. I am not a huge fan of trading short term. However, there are many traders who very well trading the smaller time frames.
In this article I want to look at how safe long term investing in the stock market is. My view is that long term investing can be one of the safest ways to invest your money. However, just like short term trading the entry can be extremely important.
Many investors take the view that timing isn’t too important if you take a long term view, because the market should rise in the long term. I personally do not share this view.
There have been several occasions over the past century where the major stock markets have crashed and it has taken several years and in some cases even decades to get back to break even. If inflation over this time is factored in, the time frame would be even longer.
I think it’s always vital to factor inflation into the scenario when investing for the long term. The reality is that if your investment value does not increase, inflation causes your money to lose value in real terms.
The most recent example of a crash and subsequent recovery is the roaring tech boom of the late 1990’s. On January 4th 2000 the Dow Jones made a record high at that time, after growing considerably for years. Many of the tech stocks like Yahoo and Microsoft became massively overvalued.
The market later corrected itself as you can see below:
Notice as well from this chart. It wasn’t until late 2006 that this high was reached again, over 6 years later. If you had invested in the stock market in 2000, the chances are you would have lost money and have to wait several years to get back to break even. If you factor in the value of your investment lost to inflation, it would be even longer.
There were major stock market crashes that took years or decades to recover from in 1929, 1973, 1987, 2000. There will undoubtedly be many more in future years.
So what does this tell us?
To put it simply don’t buy high. If the stock market has been growing excessively for years without the fundamentals to back up the growth, there is a good chance the market will crash at some point in the future, like on the occasions mentioned above.
During a stock market crash, price movements are often erratic and volatile. This is often due to human emotions getting involved, primarily fear and panic.
This is often the best time to buy in my view. The market often becomes undervalued at this time. There is no need to pick the bottom, it is often not realistic or necessary.
I understand it’s often nice to be “in the market”, but sometimes a little patience can go a long way. The last thing you want to do is buy at the top then subsequently have to spend the next five years waiting for it to get back to break even. You can do much better than that with a standard savings account offered by your bank.
Power of Compounding
One major consideration for long term investing is the ability to utilize the power of compounding. This simply means that as an investment grows in value, it can grow increasingly over time, or if you want a fancy word, it will grow exponentially.
For example if an $10,000 investment grew at 10% per year, it would grow $1000 in the first year, $1100 in the second and $1200 in the third.
Over the long term this can make a significant different to your investment value.
Long term buy and hold investing is my first choice. However, it is not for everyone. There are many factors that need to be considered when making the decision such as your age, investment objectives, appetite for risk and future expenses.