Using long term thinking when investing is very important. It’s greatest importance will be felt in the long run on performance, but it matters most when evaluating your investment allocations and the investment’s you want to include in your portfolio. For example, if you have twenty years, and you prefer a passive approach to investing, then knowing that over historical time frames that a major index ETF or fund returns 7% on average you will most likely double the initial investment every ten years. With a twenty year time frame you would double your money twice meaning starting with ten thousand dollars you would end up with forty thousand dollars in twenty years if the investment is left alone. The hard part is most investors don’t have the behavioral ability to let their investments alone.
Long term thinking also matters if you are looking at an individual business from a value approach, since it forces the decision process to say I am in this for the long term, so I had better spend the time making sure I understand this investment. Long term thinking promotes greater diligence on research and a choice. Knee jerk reactions rarely turn out well in most endeavors especially investing. Long term thinking stops this.
Here’s why long term thinking also matters. The chart below comes from Aswath Damodaran’s article, Market Risk and Time Horizons. It’s a study of market returns from 1926 to 1997. As you can see a long term perspective increases your chances of success.
|Holding Period||Best Return||Worst Return|
Fidelity investments performed a study examining the behavior of their best-performing accounts. “When they contacted the owners of the best performing accounts, the common thread tended to be that they had forgotten about the account altogether.” The Laws of Wealth, by Dr Daniel Crosby. There are also studies done by Vanguard and Meir Statman, mentioned in my article “The Hardest Thing to Do” that shows the effects of those who mess with their accounts versus those that don’t, and in both cases those that leave their accounts alone outperform those that don’t. In all these examples, and from my research, most of the reasoning behind this is because when investors try and time the market’s they generally lose, because they don’t have the emotional strength or toughness to do the right thing which can feel very scary when in the midst of it.
Bottomline, think long term, and look long term. This doesn’t mean turning a blind eye to major changes that could occur with any investments. If a company gets taken over, or it has changed it’s products or services, or leadership changes don’t seem to be solid it could be time to find a different investment.