It is often recommended by financial advisors that people should only consider investing in stocks and shares if they intend to not need the money within the next five years. The main reason for this is that the stock market can be very volatile in the short term. For example, the United States’ S&P 500 index lost nearly 40% of its value in 2008. This would not have been a good outcome for an investor wanting to utilise investments in this fund shortly after the drop. However, there are other benefits of adopting a long term approach to investing, which are often overlooked or which are not widely taken seriously.
The early bird catches the worm
By definition long term investing also means that the investor would have established their portfolio relatively early and after several years of regular investments the portfolio would have grown to a substantial size. When you look back at prices for shares it is often astonishing how “cheap” they were a only a few years back, as the prices generally go up over time. Therefore, you want to buy as many shares as you can as soon as you can.
A good example of this is that the UK FTSE 100 index was valued at 3,530 in March 2009 and it is currently valued at 7,438, nearly double! This means that you would need significantly more money to buy a unit of a FTSE 100 fund today than if you had started early. Instead of you working harder for your money you want your money working harder for you.
It is all about dividend income
The advantages of investing early would have been further significantly magnified by the regular payment of dividends, every year, for example since 2009 in our case here. An index tracking fund for the FTSE 100 would have been paying dividends with an impressive annual yield of over 3%. The power of this effect is better illustrated by the following example.
An initial amount of £1,000 invested in the FTSE 100 in 2009 would have yielded approximately £30 in that year, considering a dividend yield of about 3%. Assuming an achievable annualised growth of 10% for the FTSE 100, the portfolio would have grown to £2,144 in 2017. Using the same 3% yield, in 2017 the portfolio would yield £64, an ever increasing amount with each year for the long term investor.
Here is the interesting part – How does this £64 compare in relation with the amount initially invested. In just eight years the £1,000 initial investment would be paying dividends with an ever increasing yield of 64/1,000 = 6.4%. This is particularly significant as there are very few investments which can offer yields like this without taking on immense risks.
Long term investments can eventually pay you back and more
When done in the right way, long term holding in business or stocks and thinking ahead should eventually repay the initial investments and keep on giving. Warren Buffett has been quoted saying “our best holding period is forever” and that the best days of the economy or business always lie ahead.
Case Study: See’s Candy
Buffet has also mentioned that See’s Candies, the manufacturer of candy, particularly chocolates, has been his best ever investment. In 2007 Buffett described See’s as “a prototype of a dream business”. See’s is now a business wholly owned by Buffett’s Berkshire Hathaway. Founded in 1921 by the See family, See’s was acquired by Berkshire Hathaway in 1972 for $25 million. At that time, See’s was generating annual pre-tax profits of $4 million. By 2016, over 40 years later, See’s was generating a phenomenal $100 million in annual profits. This means that the company now makes four times its original cost, each year! In 2011, Buffet noted that See’s had brought in an astonishing $1.65 billion of profits since the initial purchase.
This just shows how shrewd investments, including others like Coca Cola which has more than tripled in value, held over long periods of time, have enabled Buffett to build enormous wealth.
I believe that all investors, large and small, should take this very sensible approach while avoiding trading in and out of positions impulsively. This not to recommend investing in individual company stocks, but instead to invest by buying and holding low cost passively managed index funds such as those provided by the Vanguard investment management company.
Eventually, the patient investor will start reaping the benefits after employing this long term buy and hold strategy and reinvesting dividends while making regular investments. This is a solid path to building a machine capable of generating passive income, which will help in attaining financial independence.