In today’s world, convenience is often a single tap away. The breadth of smartphone apps enables us to have groceries delivered to our doors within hours or hail a ride to the airport within minutes. Even social exchanges occur in real time due to the immediacy of texting and social media messages. While we are privileged to benefit from various digital advancements, they can fundamentally change our psychological disposition, conditioning us to expect results at unprecedented speed.
Yet, when it comes to investing, instant gratification remains elusive. Daily price swings often reflect transient factors like investor mood and trading signals, rather than actual changes in a company’s value. Building wealth through compounding takes time because the things that make companies more valuable rarely take shape overnight.
In a digital age characterized by a persistent flow of information and near-constant updates, maintaining a long-term perspective is increasingly challenging. Nevertheless, we’ll explore a few reasons why a commitment to long-term thinking remains helpful for yielding superior investment outcomes over time.
Long-Term Investing Has Become Less Competitive
The composition of stock market trading volume has changed significantly in recent decades, in part reflecting this shift toward shorter-term thinking. Lower commissions and online trading have fueled an explosion of short-term trading. High-frequency professional traders represent a meaningful portion of trading volume. They aim to profit from small price signals by leveraging powerful computers and sophisticated algorithms to execute trades at lightning speed. Even institutional investors focused on company fundamentals increasingly incorporate alternative data (credit card transactions, satellite imagery, etc.) to uncover unique insights that inform short-term investment strategies. Additionally, most Wall Street research reports don’t offer forecasts beyond two years. These factors have contributed to a persistent decline in how long investors hold onto stocks, from an average of eight years in the 1950s to under one year today.
Although there are skilled investors who can capitalize on short-term views, it is difficult to gain an informational advantage that delivers unique insights into a company’s near-term prospects. As such, we believe maintaining a long-term orientation suits most investors.
Indeed, the current structure of market participants creates opportunities for long-term investors. The myopia of some investors, coupled with algorithmic trading that generally prioritizes price signals over company fundamentals (earnings, cash flows, etc.), creates attractive opportunities for investors who look beyond the near term. In short, long-term investors are playing a different game, one with less competition.
Prioritizing Long-Term Earnings Growth Should Yield Better Outcomes
Legendary investor Warren Buffett uses a baseball analogy to describe his investing approach. He aptly points out that there are no umpires calling strikes in investing, so there is no penalty for letting pitches pass by. This means one can be patient and wait to swing only at pitches that are in their sweet spot, when the odds are most in their favor.
At Clifford Swan, our sweet spot comprises high-quality companies with durable competitive advantages, strong financials, and capable management teams. These characteristics tend to drive earnings growth, which is cited as the primary determinant of equity performance over the long term. By narrowing the investable universe to companies with proven track records of earnings growth, we take comfort in the alignment of our investment process with what matters most over the long run. While short-term disruptions and business cycles are inevitable, we believe long-term investment outcomes will ultimately reflect the quality of this process.
Operating with a Long-Term Mindset Helps Make More Informed Decisions
to forecast how stocks will perform in the near term, predictability increases as the investment period lengthens because long-term returns tend to converge toward their historical averages. For example, we know that equity returns are more volatile than those of fixed income or cash over the long term, but, historically, the risk of loss diminishes the longer you invest. Since 1980, the average intra-year drawdown for the S&P 500 Index has been 14%. Yet, returns were positive in 34 of the 45 years, with results becoming even more favorable over extended periods. Downside risk is often considered to be the price of admission for capturing long-term growth, and equity investors have been rewarded for tolerating volatility as returns have exceeded those of fixed income, cash, and inflation over long periods.
Long-term thinking is not always easy, especially in times of extreme market swings. However, recognizing that market fluctuations occur and maintaining a steady temperament is critical. Attempting to move in and out of the market to avoid losses typically destroys value because the best days often follow the worst days, and missing those best days can significantly reduce long-term returns. Selling after a market drop can lock in losses or trigger capital gains taxes, both of which erode returns over time. More importantly, such actions reduce the likelihood that one is invested to benefit from subsequent recoveries. Staying invested with a long-term mindset allows portfolios time to rebound from temporary shocks and compound over time while minimizing the tax consequences of market timing.
Ultimately, investors who understand the long-term risk and return profile of equities can reduce the probability of making value-destructive decisions based on short-term market movements.
The above information is for educational purposes and should not be considered a recommendation or investment advice. Investing in securities can result in loss of capital. Past performance is no guarantee of future performance.
