The stock market and long-term investing
If you look year-by-year at the last 50 years in the S&P 500, you’ll see that markets tend to deliver exactly what J.P. Morgan said they would. Following the April-November recession of 2001, markets had three years of solid losses from 2001 through 2003 (-9.11%, -11.98%, and -22.27%, respectively). Balancing these out have been gain years like 1975 (38.46%) and 1995 (38.02%).
The takeaway from looking at annual results versus a longer time frame is why long-term investing is such a powerful concept. Although analysts and advisers can predict that a pullback is due or anticipate a good year on the horizon, the unexpected can and does happen. There’s no foolproof way to anticipate losses or major gains in the market.
Ideally, an investor should, as the old chestnut goes, “buy low and sell high.” Accomplishing that isn’t as easy as it sounds. Markets that are falling can always fall more, while those that are gaining can go higher still—a disappointment to those who sell early.
Research has shown that, too often, investors buy after markets have recorded significant gains, then get nervous and sell when they fall. The typical consequences of this approach are subpar returns.
Hindsight will tell you whether you bought too high or sold low. Financial advisors and traders rely on a set of tools that generally inform them better than pure instinct. These sometimes include:
- Moving averages: Moving averages show price fluctuations over time; in other words, they’ll give you a sense of the stock’s general trajectory over time. A common method is to look at 50-day and 200-day moving averages. When these averages cross certains thresholds, investors sometimes use them to make buy or sell decisions.
- Business cycle: The economy moves up and down, from expansion to recession, in what’s known as the business cycle. Where it stands at any one point can inform an investors’ decisions. During a recession, long-term investors try to take advantage of discounted share prices, anticipating a rise once the economic slump ends.
- Sentiment: Sentiment is sometimes used to gauge the direction of the market. Are investors optimistic or pessimistic about the future? This is sometimes used by investors as a contrarian indicator.
Market timing
Statistically, investors who try to time the market or trade their way to fortune with short-term moves overwhelmingly earn returns that fail to match the S&P 500. Plus, this kind of strategy often takes up a disproportionate amount of the investor’s time and results in fees and taxes that eat into returns. It’s nearly impossible to predict market shifts consistently enough to gain an advantage over an investor who buys and holds high-quality stocks over a long period of time.
Why the market is geared toward long-term investments
History tells us that the stock market has increased more years than it has fallen. This is a basic truth that is helpful for those who are beginning to invest; it’s also what leads us to that long-term return of an annualized historical average return of 7%.
The S&P 500 has gained in 40 of the last 50 years. There’s a simple explanation for this: As the economy grows, investments might gain or lose value in any one year, or even for several years, but keeping them for a long period of time buffers the extreme moves that markets always have.
