They try and hit a quick ’home run’
I was on Breakfast Television in Calgary this morning promoting my new book Rich by 40. I also talked about staying invested for the long term. Watch the segment by clicking here.
Successful investors like Warren Buffett and the late Sir John Templeton, both billionaires, have cited quality long-term investing as the key to their success. Dalbar Inc. conducted a study in 2006 indicating that over the long term, investors who hopped from investment to investment, trying to earn huge returns very fast (a quick ‘home run’), earned less than 4 per cent in annualized returns on their portfolios. That’s barely above inflation, which has averaged 3.5 per cent for the past thirty years. Meanwhile, investors who simply bought the stock market index, a standard benchmark, have earned between 10 and 12 per cent in annualized returns in the long run.
Warren Buffett’s Buy-and-Hold and Value Investing stock purchasing strategies have been extremely successful. According to Buffett, “Only buy something that you’d be perfectly happy to hold if the market shut down for ten years.”
You can see for yourself exactly what people like Buffett and others are buying by visiting Morningstar.com, Morningstar.ca, or the Securities and Exchange Commission website www.sec.gov. You can even track his company Berkshire Hathaway Inc through Yahoo! Finance.
The buy-and-hold approach to stock purchasing is fairly conservative in that the investor purchases very high-quality (non-risky) stocks and holds onto them for years. It is a long-term approach to investing and the investor makes money when the stock appreciates in value and through dividends. Because there’s little trading involved, the investor doesn’t hop from investment to investment, paying high fees and not realizing the stocks’ full potential.
Buffett couples this with the more active and slightly less conservative Value Investing approach. The same principles apply, but he takes it one step further. Buffett buys quality stock that is beaten down or undervalued due to economic conditions or short-term hiccups. According to Buffett, “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”
To implement this strategy, investors must first understand and pay close attention to businesses that have been hit by short-term struggles. If it appears the company can overcome its challenge (and if the research supports this), then an investor can exploit low share prices.
The value-investing approach can also be applied when the economy is struggling. For example, many quality companies were hit hard by the financial crisis of 2008-2009. Their share values plummeted even though their fundamental qualities and business practices didn’t change. Based on the fact that the quality was still intact, value investors, including me, jumped into the market in the trough, buying high-quality, undervalued stock. The price of one Royal Bank share, for example, was more than $50 at the beginning of 2008; early in 2009, amid the economic meltdown, its shares hovered below $30. The fundamentals of the company didn’t change within that timeframe. What changed was the economy as a whole. Many value investors found opportunities to invest in similar undervalued stock. Royal Bank shares have climbed to over $50 in very recent months.
Again, the intension of a value investor isn’t to make a quick buck; it’s to buy and hold bargain-priced high-quality stock. Buying high-quality stocks and holding them for the long term make both the buy-and-hold and value-investing approaches conservative to moderate-risk strategies.
To be successful at the buy-and-hold and value-investing approaches, you need access to research (see Part 1 of Why do Investors Lose Money?), an understanding of market cycles, and patience. Janet Lowe’s Value Investing Made Easy is great book on the topic. I’d also recommend getting the advice of a professional financial advisor who can help you build a solid portfolio.
