What does it mean to be a long term investor? In this episode, Peter shares his definition of being a long-term investor and how it shapes the framework for making investment decisions.

Listen in and learn:

Episode

Outline

Time horizon is the obvious one. 

• In my conversations with other professionals, I typically hear people think of “long-term” as 10 years. I can live with that. But when I’m making a decision in my portfolio, I’m usually thinking 20 years.
• I cringe when people say 3 or 5 years is long term because outcomes are pretty random over those time frames. 
• Even 10 years is relatively unpredictable.
• But 20 years…20 years tends to be enough time to let financial theory play out, but if 20 years is our definition of “long-term,” then the long-term feels like an eternity to live through in the moment.
• Staying the course is one of the biggest challenges investors face. 
  • Whenever I’m talking to someone that wants to change course (selling out of stocks in fear or making an allocation change in response to recent past performance or some other type of prediction-based investment), I lean heavily on evidence to help them make that decision.
  • The thing with making evidence-based investments is that you have to think long-term, and that’s when I start talking about 20-year time periods.
  • A common rebuttal I get when I start talking about a 20 year horizon is: “I don’t have 20 years”
  • That’s just not true

Whatever you think you’re time horizon is, it’s longer. 

• If you’re in your 60s or 70s, you’re ignoring the probabilities if you don’t think you can live another 20 years. 
• If you’re 50 or older, you might think you don’t have 20 years if your retirement date falls before that mark. But, unless you need all of your money on the day you retire, you should be planning on having at least 20 years.
• If you’re under 50 years, I don’t think I need to convince you that you have a time horizon of at least 20 years.
• Now, I’m focused on personal time horizons at the moment, but regardless of age, people judge outcomes of long-term investments in less-than-long-term time periods. 
  • For the past several years, I’ve found myself frequently answering questions about owning non-US stocks because the S&P 500 has trounced it for well over a decade. Since March 2009, just about everything has underperformed the S&P 500, so this comes up in a variety of conversations.
  • Of course, near the end of 2000s, nobody wanted to own the S&P 500, noooo…The S&P 500 had a negative average annual return in the 2000s. And from 2000-2012 it underperformed T-Bills!
  • Back then, everyone wanted more emerging markets. More developed international, too, but especially more emerging markets because China was going to dethrone the United States – 
• Anyways, Fast forward a decade and people want more of the S&P 500 because it’s doing better than everything else.
  • Nobody wants emerging markets now that it has underperformed for the past 10 years. But when you look at the full 20 year period, Emerging Markets is still winning. People forget. 
• If you are evaluating the validity of being a globally diversified investor, that 20 year period ought to begin when you started. 
  • So if you invested in a globally diversified portfolio in 2015, then it’s only been 6 years – maybe you ought to wait another 14 years before deciding to only invest in the S&P 500, which is not really an appropriate standalone benchmark, but the topic of benchmarks would require it’s own episode, so I’ll set that aside for now.
• If you are making a change in your portfolio, I think you need to be making that change with a multi-decade horizon. So the next 20 years is really just the starting point for a long-term investor.

I love an example from Warren Buffett gave about a 20-slot punch card. When I evaluate a portfolio change for myself or for clients, I like to think in the context of Warren Buffett’s 20-slot punch card. Buffett says:

“I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches – representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all. Under those rules, you’d really think carefully about what you did, and you’d be forced to load up on what you’d really thought about. So you’d do so much better.”

A big part of successful investing is avoiding mistakes and this framework reduces the opportunity for performance chasing or reactionary moves while highlighting only your best ideas. Equally important, this framework emphasizes a patient process and long-term mindset. 

Long-term investors should make investment decisions within the context of a multi-decade time horizon. The long-term feels like an eternity to live through in real time. The basic pieces of financial theory may appear broken over any given market cycle, but they tend to shine bright when you allow them enough time to work.

So the obvious part of being a long-term investor is having a long time horizon…but why is that important?

A long time horizon is important because time mixed with the power of compounding is the most potent combination for wealth creation. 

Compound interest isn’t linear – it’s exponential. The human brain isn’t good at visualizing exponential things, which may explain why it’s so difficult to fully appreciate a plan that fully leverages the power of compounding.

Let’s try to fix that…

Imagine you take a sheet of standard printer paper with a thickness of 0.1 mm.

Fold it over once and it gets twice as thick. Fold it again and you’ve doubled the thickness of the paper again; two folds make the paper four times as thick. Fold it a third time and now the paper is eight times as thick.

If you could fold that piece of paper 50 times, the paper would stretch 95 million miles or approximately the distance from Earth to the sun.

At 100 folds, it matches the radius of the universe.

Unfortunately, it isn’t possible to fold a piece of paper more than eight times (try, I dare you). But the underlying math of repeatedly doubling the thickness of paper is exciting when we apply the same exponential growth to your wealth.

Let’s take another example to see how good planning can maximize the benefit of compound interest: Ben Franklin

At his death, Franklin’s will left 1,000 pounds sterling (then worth about $9,000) to his adopted home of Philadelphia and his native city, Boston.

Franklin wanted trustees to loan the money to apprentices, much in the same way he received assistance early in his career. His will also stipulated that the interest collected from the loans should stay invested so it could compound over time.

After 100 years, both cities could withdraw 75 percent of the funds to use for infrastructure projects that would improve the quality of life for those living in these cities like bridges, roads, water systems, and public buildings.

Then in another 100 years, the cities could withdraw the remaining balance for additional infrastructure and city betterment projects.

Franklin estimated a 5 percent annual rate of returns from the loans. It turned out to be 4 percent. He was off by one percentage point, but remember that financial success depends less on marginally higher returns than it does on saving and time. This case serves as a perfect example of this phenomenon.

The cities made their first withdrawals in 1890. The fund grew from Franklin’s initial contribution of $9,000 to $500,000 over a period of 100 years (that’s about $13 million in today’s dollars).

When the cities could make their second withdrawal in 1990, they gained access to another $6.5 million (or $12 million in today’s dollars).

Franklin understood the power of compounding and knew that good planning and time were the essential ingredients to having it work in your favor.

You probably won’t get to work with a 100-year time horizon, but being a long-term investor should mean you have several decades to allow your investments to earn compound returns.

The way Franklin structured his will provides a great illustration of how thoughtful planning and time can best capture the power of compounding. The more time you have, the more your wealth benefits from this compounding effect.

That’s why Warren Buffett says, “Life is like a snowball. The important thing is finding wet snow and a long hill.”

Think about it: As a snowball rolls along, it collects more snow with each rotation. The further it rolls, the more mass it can exponentially gain.

• The wet snow is the interest you reinvest to pick up even more interest as you roll along.
• The long hill is the multiple decades you give yourself if you are truly a Long Term Investor.

Once you create a well-thought-out plan that focuses on maximizing your wealth as a means to meet your goals, you can sit back and let time do its thing.

Small Decisions and Good Habits Lead to Big Results

And this is not just an investment issue. Time and the power of compounding can turn small decisions and good habits of all sorts into incredible results.

• Should you invest or pay down debt?
• Where should you keep cash savings?
• What types of investment accounts should you use first?
• Should you rent or buy a home?
• What percentage of your income should you save?

The decisions you make today will have compounded effects decades later. Which is why I’ve historically written on both investing and financial planning topics. That’s what I think being a long-term investor is all about.

I also think being a long-term investor means doing nothing more often than something.

Being active in the areas that you can control, like financial planning, is one thing, but changes to a portfolio should be few and far between.

One Final Thing as we define what it means to be a Long Term Investor….The Long Term Investor is an Optimist 

During times of uncertainty, we tend to gravitate towards high-conviction predictions eloquently presented by persons of authority or special expertise. But you must be careful when consuming predictions of what happens next – especially when people start proclaiming doom and gloom scenarios for the future.

There’s plenty of research that shows us how people hate to lose money more than they like making it. This natural aversion to losses and pain makes it more likely you’ll gravitate to a pessimist’s outlook and think that take sounds smarter and more informed. (And in this age of social media and 24-hour news, you’ll find no shortage of negativity to consume.)

Being an optimist doesn’t mean ignoring the fact that things are bad and could get potentially worse. But betting against the human spirit has historically been a bad bet. And if you think things will never get better, the evidence is stacked against you.

A devoted student of history knows that every downturn is different and scary in its own unique way. The common thread in all of them is that eventually the human spirit prevailed.

I don’t know when or why the next downturn will happen, but I know that it will happen with a similar magnitude and frequency as it has in the past.

And once we’ve reached this unknown crisis, I won’t be able to tell you when it will end, but only that I know it will end.

I’ve long believed that the key to investment success is minimizing mistakes. Believing the future will not get better for ourselves or financial markets is a devastating mistake.

In periods of uncertainty, the market requires you to embrace fear and uncertainty in exchange for the returns you need to compound your wealth over time. 

Unless you need your entire portfolio to meet living expenses in the next year, the benefit of missing some of the downside is far less impactful than ensuring you capture the upside whenever it comes.

That’s all I have for today. If you enjoyed today’s show, please subscribe and leave me a review. Once I get a few episodes under my belt, I’ll begin incorporating questions from my readers and listeners. 

If you want additional educational materials customized to your specific situation, head over to SmartMoneyQuiz.com where you can answer a few simple questions and then I’ll send you the content of mine based on your responses.

Resources

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About the Podcast

Long term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence. 

Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.

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