I’m married. Marriage is about commitment and patience. Marriage is not for the impulsive or the fickle. There are going to be ups and downs, good times and bad times. Through all of that, I firmly believe marriage is ‘worth it’ a million times over.
What does marriage have to do with long-term investing?
Keep reading to see why commitment matters in marriage, and in your investment portfolio.
In marriage, you get to build the deepest relationship of your life. All the little (and big) nice things you do for someone else are added to the ‘love bank’. These little deposits grow over time. You get the interest on your investment through reciprocity; the person you love most in the world doing little (and big) nice things for you.
The draw of marriage is building a deeper, longer bond with one person than you will with anyone else. That is very special.
Society knows marriage is special. That’s why getting divorced is a difficult process. You can’t just tell your spouse ‘we are divorced’ and be done with it. When you give your life-long (and legal) commitment to someone, you can’t just walk out the door with no strings attached.
What if we approached owning our stocks with the same conviction? That’s what long-term investing is about.
“People have a way of looking at me strangely when I tell them that long-term investing isn’t about having a great system, or a superior analytic intellect, or better access to information, or even the best advice money can buy. Long-term investing is about character, about depth of vision and the cultivation of patience, about who you are and who you’ve made yourself to be”
The Single Best Investment, page 149
Table of Contents
- Long-Term Investing Definition
- Why You Need to Become a Long-Term Investor
- Long-Term Investing Strategy
- Long-Term Investing Examples
- Stocks for Long-Term Investors
- Long-Term Investing Is Difficult
- The Cure: Watch Dividends, Not Stock Prices
- The Difference Between Buy & Hold and Long-Term Investing
- Long-Term Investing Calculator
- Final Thoughts
Long-Term Investing Definition
What is long-term investing? I define it as follows:
Long-term investing is the process of buying and holding investment securities you believe will compound investor wealth indefinitely into the future.
Why You Need to Become a Long-Term Investor
There are 3 good reasons to become a long-term investor:
- It reduces fees
- It requires less of your time
- It is highly effective
Every time you buy or sell a stock you incur transaction costs. Buying and holding indefinitely reduces fees. In taxable accounts, this is especially important. When you hold a stock that has capital gains you are in effect allowing the portion of those gains you owe to the government to continue to compound in your investment. This has a powerful effect on your investment over time.
Time is money. The purpose of life is not to manage your investments… I don’t know what the ultimate purpose is, but I can say from experience it is not analyzing potential investments. Long-term investing requires less of your time. Once you buy a high quality stock you believe will maintain its competitive advantage indefinitely, your work is done. All you have to do is periodically (quarterly would be plenty) check in on the company to make sure it is performing reasonably well. You don’t have to find other quality investments tomorrow, next week, or even next year… The money you’ve invested is safely compounding away.
Long-term investing is highly effective for a few reasons. One of those reasons is it reduces fees (as discussed above). Your money should be left to compound in your account, not paid to your brokerage in the form of transaction costs.
Another reason long-term investing is so successful is because of its beneficial psychological ramifications. If you invest for the long-term, you will focus on businesses with strong and durable competitive advantages that have a chance of compounding your wealth for decades, not days.
But don’t take my word for it… See below for several quotes on long-term investing from some of the world’s greatest investors:
Seth Klarman is founder of the Baupost Group hedge fund. His current net worth is around $1.4 billion.
Philip Fisher is the pioneer of growth investing and author of Common Stocks and Uncommon Profits.
Warren Buffett is the founder of Berkshire Hathaway (BRK.A). His current net worth is around $62 billion.
Long-Term Investing Strategy
The strategy long-term investors follow is straight-forward:
- Identify companies with durable competitive advantages
- Be sure these companies are in slow changing industries
- Invest in these companies when trading at fair or better prices
This 3 step-process greatly reduces the field of stocks that investors have to choose from. There are a few ‘hacks’ to quickly find businesses trading at fair or better prices with durable competitive advantages in slow changing industries.
To find stocks with durable competitive advantages look through this list of Dividend Aristocrat stocks. To be a Dividend Aristocrat, a stock must have paid increasing dividends for 25+ consecutive years. That is no simple task; it requires a strong and durable competitive advantage.
There are many slow-changing sub-industries. Slow changing industries will typically be low-tech. They will sell products that people need in good times and bad times. Slow changing industries will tend to have many stocks with very long corporate histories as well. Three of my favorite slow changing industries are:
- Health care
- Food and beverage
To find if a company is trading at ‘fair or better prices’, a few metrics are important. The first is the company’s price-to-earnings ratio. If the company is trading below the market price-to-earnings ratio, its peer’s price-to-earnings ratio, and its 10 year historical average price-to-earnings ratio, it is likely undervalued. These 3 relative price-to-earnings ratios will help to paint a picture of if a stock is ‘in favor’ or ‘out of favor’. As a general rule, it’s best to buy great businesses at a discount – when they are out of favor.
Another good metric to look at for determining value is a company’s expected payback period. Payback period is calculated using an expected growth rate and a stock’s current dividend yield. The higher the dividend yield and expected growth rate, the lower the payback period. The payback period is the number of years it will take an investment to pay you back. Obviously, the lower the payback period, the better. Click here to find a payback period calculator.
Long-Term Investing Examples
Warren Buffett’s investment history is perhaps the best example of long-term investments. Three of his longest running investments are below:
- Wells Fargo (WFC) – 25% of his portfolio – First purchased in 1989
- Coca-Cola (KO) – 15% of portfolio – First purchased in 1988
- American Express (AXP) – 11% of portfolio – First purchased in 1964
All of these three investments are 25 years old or older. The American Express investment is especially impressive. Warren Buffett has held American Express for over 50 years!
Another example of long-term investing success is to examine the history of several Dividend Aristocrats. The image below shows the returns of the top 9 Dividend Aristocrats from 1989 through May of 2014.
VFINX is a mutual fund proxy for the overall market in the image above. Of course, not all long-term investments will generate such impressive long-term results. The image above proves that high quality businesses have the potential to generate excellent compound returns over decades.
Stocks for Long-Term Investors
The Sure Dividend system is specifically designed to find high quality dividend growth stocks suitable for long-term investors.
To that end, Sure Dividend uses The 8 Rules of Dividend Investing to identify high quality dividend growth stocks trading at fair or better prices.
A brief list of blue-chip stocks worthy of long-term investors that are currently trading at fair or better prices is below. One for each sector of the economy is shown:
- Basic Materials: Phillips 66 (PSX)
- Consumer Goods: General Mills (GIS)
- Financial: Aflac (AFL)
- Health Care: Johnson & Johnson (JNJ)
- Industrial Goods: Deere & Company (DE)
- Service: W.W. Grainger (GWW)
- Technologies: Verizon Wireless (VZ)
- Utilities: Southern Company (SO)
Long-Term Investing Is Difficult
Please don’t get the wrong idea – long-term investing is not easy.
It is psychologically difficult to hold a stock when its price is declining.
Holding through price declines takes real conviction (remember the marriage analogy?).
Can you imagine how many more divorces there would be if getting divorced was as easy as trading a stock? The nearly infinite liquidity of the stock market combined with the ease of trading makes selling stocks something you can do on a whim.
But just because you can, doesn’t mean you should.
The constant stream of stock ticker price movements also coerces individual investors into trading unnecessarily. Does it really matter that a stock is up 1% today, or down 0.3% this hour? Have the long-term prospects of the business really changed? Probably not.
To compound these problems even further, the financial media promotes rapid action. To garner views and attention, financial pundits have become LOUD. They are always promoting the next great stock to buy, or which one MUST be sold.
The Cure: Watch Dividends, Not Stock Prices
Stock prices lie. They signal a business is in steep decline, when it isn’t. They say a company is worth 3x as much as it was 3 years ago, when the underlying business has only grown 50%. Stock prices only represent the perception of other investors. They do not and cannot show the real total returns an investment will generate.
Instead of watching stock price, avoid them completely. Look at dividend income instead. Dividend do not lie. A business simply cannot pay rising dividends for any protracted period of time without the underlying business growing as well.
Dividends are much less volatile than stock prices. Dividends reflect the real earnings power of the business. As a result, it makes sense to track dividend income rather than stock price movement. After all, don’t you care what your investment pays you more than what people think about your investment?
The Difference Between Buy & Hold and Long-Term Investing
There is a difference between buy and hold (sometimes called buy and pray) investing and long-term investing. Buy and hold investing typically means buying and holding no matter what.
That’s not what I advocate, and that’s not what long-term investing is about.
Sometimes, there is a very good reason to sell a stock. It just happens much less frequently than most people believe.
At Sure Dividend, we sell a stock for 2 reasons:
- If it cuts or eliminates its dividend payments
- If it becomes extremely overvalued
The first reason to sell is intuitive. If you invest in a business to provide you steadily rising income, and instead it reduces or eliminates its dividend, that business has violated your reason for investment.
When a stock cuts its dividend, it violates your reason for investing. Using the marriage analogy, if you and your spouse agreed to be faithful to each other and one spouse violates this sacred agreement, then the ‘contract’ of the marriage has been violated. It’s the same when a stock violates your reason for owning it.
The second reason to sell is in the case of an extreme overvaluation. I’m not talking about when a stock moves from a price-to-earnings ratio of 15 to 25. I’m talking about when a stock is trading for a ridiculous price-to-earnings ratio; something like 40+. An important caveat to remember is to always useadjusted earnings for this calculation. If a cyclical stock’s earningstemporarily fall from $5.00 per share to $1.00 per share, and the price-to-earnings ratio jumps from 15 to 75, don’t sell. In this instance, the price-to-earnings ratio is artificially inflated because it is not reflecting the true earnings power of the business. Selling due to extreme valuations should only occur very rarely, during extreme bouts of irrational market exuberance.
Long-Term Investing Calculator
To calculate the long-term value of an investment, use the quick and easy Excel spreadsheet calculator below.
The calculator uses dividend yield and expected growth rate to calculate the long-term total returns of an investment.
Investing for the long run is simple, but not easy. It is psychologically difficult. The amazing success records of investors who believe a long-term outlook is critical for favorable investment returns lends credibility to the idea of long-term investing.
The financial media does not typically discuss the merits of long-term investing because it does not generate fees for the financial industry, and it does not lend itself to flashy headlines or catchy sound bites.
I personally invest in high quality dividend growth stocks for the long-run. I believe that high quality dividend growths stocks with strong competitive advantages offer individual investors the best available mix of current income, growth, and stability as compared to other investment strategies and styles.
Long-term investing requires conviction, perseverance, and the ability to do nothing when others are being very active with their portfolios. Do you have what it takes to invest for the long run?