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8. Investing over time

I discussed in previous articles:

  • How mindfulness can help make you a less emotional and more rational investor
  • The near impossibility of “beating the market”
  • Low-cost stock index funds are a superior investment in most cases
  • How to appropriately diversify your assets.

To create a complete and coherent investing plan, we need to apply these mindful findings over time.

The solution of time

Popular finance websites and books often discuss investing over time as a “problem” that individual investors need to “overcome” to reach investing nirvana.  I think a more mindful perspective is that time is the solution.  In fact, I’ll wager that time is a potential solution to almost any problem you have in life.  Leaving aside money problems for a moment, look at some of the most common problems in life and consider how time can solve or minimize almost all of them:

  • Too busy – People seem to complain about this almost daily.  The role of time here is obvious.  If you had more time, you could thoroughly and calmly address each task in turn and that busy feeling would disappear.
  • High stress and tiredness – This is virtually the credo of modern times.  You can reduce stress levels by arranging more time for activities such as outdoor recreation, organized sports, social interactions like clubs and churches, exercise in general, just taking a walk, listening to music, and, dare I say it, mindful meditation.  Similarly, you can reduce your tiredness by allowing more time for sleep.
  • Health problems – It’s a given that everyone suffers declining health and eventually, death.  However, many health problems can be mitigated through time.  For example, heart disease is the most common health issue in America, and it can be minimized by losing weight, eating healthy, and not smoking.  These goals are easier to accomplish when you take the time to work toward them.  Conversely, spending less time on things that contribute to heart disease, like being a snack-eating couch potato, is another way that time can help.
  • Relationship problems – This one is pretty obvious.  Do you think your relationships with family, friends, colleagues, co-workers, and even “enemies” will get better or worse with the more time you devote to them?  You may still not have an ideal relationship with someone after prolonged constructive effort, but it’s unlikely your relationship will be worse.

By now you are probably muttering to yourself, “But I can’t simply make more time.”  Are you so sure?  The ancient philosopher, Lao Tzu purportedly said:

  • Time is a created thing.  To say, “I don’t have time.” is like saying, “I don’t want to.”

For example, did you know that the average American spends 5 hours a day watching television and over 10 hours a day consuming electronic media in general?  While sometimes enjoyable, such activities are certainly not essential and present an opportunity to “make” more time to address any of these problems.  Further, Buddhists point out that time is central to our perception of our own lives.  Mindfulness allows us to see that all things change over time; nothing is static.  Therefore, a temporary acceptance of present conditions is logical.  In other words, if you don’t like the weather right now, just be patient, and it will be different soon enough.  If we can perceive changes across time not as threats but as unfolding opportunities that we can patiently explore, many time-related problems diminish or even disappear.

Time and investing risk

Although you may not entirely agree, let’s say for the sake of argument that time can solve every problem.  So, what does that tell us about investing?  As we have seen in previous articles, buying and holding stocks over long periods of time is a mindful investing approach.  But those “risky” stocks will periodically backtrack and lose value temporarily due to price volatility.  With a sufficiently long time horizon, there is little risk to stock investing, because the impacts of stock volatility become less over time.  Here’s a chart from JP Morgan that shows how stock return volatility becomes dampened with longer holding periods.  The graph also shows portfolios of bonds and a mixture of bonds/stocks for comparison.  More importantly, the chart shows the range of total returns for stocks was rarely negative for a holding period of 5 years and never negative after more than 10 years.

As discussed in earlier articles, we should be careful when extrapolating past performance to the future.  Nonetheless, the best information available indicates positive returns from stocks are highly likely after a holding period of about 5 to 10 years.  This is why the question of “risk tolerance” is often confused with investing time horizon.  Many risk tolerance evaluations simply accept the history of long term positive stock returns as an assumption that you will be able to tolerate any volatility along the way.  This is obviously not true for some people as discussed more in Article 4.3.

Because losing money is no fun, and stocks may take 5 to even 10 years to produce positive returns, stocks are clearly a long-term investment.  This is why Warren Buffet is frequently quoted as saying:

  • If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.

It’s interesting that Buffet also uses 10 years as an appropriate holding period for stocks, and we will explore this threshold more in Article 8.1.

You can’t choose when to invest

There is an old saying that you can’t choose when in history you were born.  You also can’t really choose when in the history of market ups and downs you have accumulated enough money to start investing.  Similarly, you can’t choose when that rich uncle will finally leave you a bundle of cash to invest.  Following this logic, many people worry about the potential “bad luck” of investing a significant sum right before a large market downturn.

Even though mindfulness tells us most worry is useless, is the “bad luck” concern real?  To answer that question we need to look at the math behind stock value growth and sporadic declines.  Let’s say you invest a chunk of money in stocks and let it ride for 30 years.  This chart shows how the total value of those stocks would change depending on whether a one-time 50% decline occurs early, mid-way, or late in the 30-year investing period.  To clarify our point, this example assumes a constant annual rate of return for the stocks of 5%, which is the mid-range of future expected stock returns presented in Article 6.2.  While constant steady growth is not how the stock market really works, this assumption removes a variable and helps isolate the primary question about investing immediately before a market decline.

As you can see, the timing of the decline makes no difference to the final outcome.  A 50% decline soon after you started investing “feels” more painful because your stock value is less than your original investment for quite some time.  (This situation is sometimes called a “negative return.”)  But this only matters if you sell too soon.  In the end, all three of these outcomes are identical, regardless of your feelings about them.  And the essence of mindfulness is recognizing when your feelings may be leading you astray.

But what about that pesky assumption of steady stock market returns?  That assumption is clearly false.  Are we potentially fooling ourselves with this simplified analysis?  Fortunately, many people have conducted very detailed analyses to answer this question.  Most involve looking at every possible moment in stock market history when you could have invested a chunk of money, which is sometimes referred to as a “Monte Carlo” analysis.  Here is an example of one such analysis from a data-minded individual investor.

This graph uses “cash multiplier” on the y-axis, which simply means how much more or less your stocks are valued at any given time as compared to the original investment amount.  Values above one mean you have positive returns, and values below one indicate negative returns.  This analysis factors in both inflation and reinvested dividends.  The green haze of lines represents all possible outcomes over the entire 145 years of U.S. stock market data compiled by Nobel laureate Robert Shiller.

Don’t try to follow any one line in this graph.  The key information is provided by the dimensions of the overall green blob.  For example, if we examine the span from about 5 to 10 years, we can see that the majority of the green blob is above the positive return value of one.  This indicates that in all U.S. stock market history the clear majority of the time you would have achieved a positive stock return by investing and holding for 5 to 10 years straight.  And once you go beyond a 20 year holding period, there is actually no time in all of the U.S. stock market history where you would have ended up with less money than when you started, even after factoring in the erosion of the value of a dollar due to inflation.

These same data can be presented more simply as shown in this graph.

The chances that you would have lost inflation-adjusted money by investing in the stock market in the past is about: 20% for a 5-year holding period, about 12% for a 10-year holding period, and about 4% for a 15-year period.

Effectively handling these sorts of bad luck probabilities is the essence of mindfulness as explored in earlier articles.  It’s worth repeating that Mark Twain is supposed to have said,

  • I’ve worried about a lot of things in my life, most of which never happened.

A mindful perspective tells us we can worry about low probability bad outcomes, but such worries are mostly just a waste of time.  When the chances of a bad outcome approach around 10%, mindfulness really helps you ignore those unlikely bad outcomes and proceed with a strategy that has a very good chance of success.  In the event that the one-in-ten bad outcome actually occurs, mindfulness also helps you effectively address that situation.  For example, the above graph is showing any loss, even the loss of one dollar.  So, a 10 percent chance of a loss does not mean you will have zero investment value left at that time.  If you continue holding those stocks for even longer periods, the odds continue to favor that you will eke out a gain relatively soon.  Mindfulness helps us realize that even this low probability bad outcome does not necessarily equate to a financial disaster.

Diving deeper

All the discussion so far assumes you are investing a one-time lump sum and not withdrawing anything to spend along the way.  These assumptions probably describe very few actual individual investors out there.  The picture gets more complicated when we address the more typical situations of saving and investing over time or entering the spending phase such as retirement.

Because more time reduces the risks of stock returns, your stock investing approach should logically vary depending on how much time you have to invest.  Way back in Article 3, I noted that we would be addressing two basic types of investors:

  1. Those who are saving and investing for the future
  2. Those who are near or in retirement.

For simplicity’s sake, we can call these “young” and “old” investors.  However, we know that some younger investors may be saving and investing for a near term reason like a business venture, and some older investors may be investing to pass on assets to their children, who will invest it for many more years to come.  Whether you fall in the “young” or “old” camp is less about your age and more about your investing goals.  Based on the information in these articles you should carefully assess the most appropriate camp for you.  To help with this assessment, we can further define the two camps as:

  1. “Young” – You have greater than 5 to 10 years until retirement or the money is otherwise needed.
  2. “Old” – You are within 5 to 10 years of retirement (or other planned money uses) or are already in retirement.

Here is where we start to use the threshold of 5 to 10 years as a “safe” time horizon for investing in stocks.  In this time range, we have about a 20% to 10% chance of a negative return from stocks.

The Series 8 articles dive deeper into more realistic investing scenarios for the “young” and “old” investors:

There are some other details we need to also consider to gain a complete view of investing over time, and these are covered in subsequent articles: