The Secrets of Investment Success

For all investors, one of the most important factors to their long-term success is the appropriate perspective and temperament toward their investments. Each year Morningstar reports on the gap between the investment returns average investors achieve and the overall return of the funds they invest in.

Assuming an investor simply held their investment in the specific fund for the entire period of time, the investor’s return and the fund’s return would be the same. The difference that arises in real life is called the behavior gap and represents the lost returns that result from individual investors buying and selling funds as they try to anticipate where the market will move next.

Morningstar’s Mind the Gap Report shows the historical behavior gap is approximately 1.5% per year. Over time, this results in a significant reduction in long-term returns for investors who try to time the market and anticipate short-term market movements.

To increase the likelihood that each of our clients achieve the long-term investment success they desire, we have compiled some of the key factors that lead to long-term success. Some of these factors were first discussed by Scott MacKillop in his article titled Ten Facts Clients Need to Know to Achieve Investment Success originally published in Advisor Perspectives in 2020. We have updated the data and added our own perspective. We’ve also included additional insights as well as a few of our favorite quotes from arguably the most successful investing duo of all time, Warren Buffett and Charlie Munger.

Charlie Munger Quote:

“The big money is not in the buying and selling, but in the waiting.”

Fear Is Expensive:

The financial news cycle generates profits from ratings and viewers. Telling everyone that things are great and the future is bright isn’t a recipe for keeping people glued to their TV sets or convincing them to subscribe to paid investment newsletters.

Individuals who spend countless hours watching financial media outlets are bombarded with news that casts doubt on the safety of their life savings if immediate action is not taken. Often the recommendation is to go to cash and wait until there is more certainty in the market or buy precious metals as a hedge against calamity.

While these steps sound logical based on the fear of the day, a look at the facts tells a completely different story. The following graphic shows the growth of $1 assuming it was invested in each asset class from 1980 through 2024.

As shown, cash equivalents (i.e. 3-month T-Bills) and gold which are often touted as the best options to protect against turbulent markets have only marginally beat inflation over the 44-year time period and have massively underperformed the results of long-term investments in US businesses.

Further, there has always been a reason to be fearful. In just the last handful of years we’ve lived through a global pandemic (COVID-19), seen growing international tensions with the Russia-Ukraine and Israel-Hamas wars, watched inflation rise to over 9% in the summer of 2022 , experienced an interest rate rise of over 5% from 2022 into 2023, and so on. Despite all of these events, the stock market and economy has continued to achieve significant growth… and a similar story can be told for almost any period in that 44-year time period.

Successful investors understand that uncertainty and concerns are part of the investing process and are not a reason to abandon their plan or avoid the market altogether. Those who have avoided the market due to fear have made an extremely costly mistake.

Warren Buffett Quote:

Warren’s following quote is from a New York Times op-ed during the Great Recession in 2008. A time when most people were extremely fearful of investing.

“Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.”

The Stock Market Is a Collection of Businesses:

After years of watching financial media and seeing stock quotes flash by on the TV screen, many individuals understandably believe that investing in the market is like gambling in a casino. Prices fluctuate in a seemingly random fashion, and they hear equally qualified individuals touting opposite perspectives for the future of specific companies.

While market movements over months and even a few years can be very random, the assumption that long-term investing is simply a gamble is misguided. Investing in the stock market needs to be understood for what it is, buying ownership stakes in real businesses. The primary difference between the stock market and buying into a private business is that the price of the public business is quoted every day. Whereas a private business has no quoted value, and often the investor goes years without knowing what a willing buyer would pay for their shares.

Another key difference between most private and publicly traded businesses is that publicly traded businesses are generally a collection of some of the most successful businesses which is what led them to go public in the first place.

The key point is that investing in the stock market is simply business ownership in a collection of some of the most successful companies the world has to offer. The fact that their share prices fluctuate based on short-term trends and information is simply a necessary evil that accompanies the privilege of being able to buy and sell shares at a moment’s notice.

Warren Buffett Quote:

“You’re not buying a stock; you’re buying part ownership in a business.”

The Market Goes Up Over Time:

Over time, the stock market goes up. The long-term returns of the market are primarily driven by the underlying cash flows and earnings of the businesses that make up the market. These cash flows are either distributed to investors as dividends or reinvested back into the business to generate additional profits and cash flows in the future.

Like a river current, these underlying cash flows carry the investor forward toward their long-term goals. While price fluctuations are the norm in the short term, the short-term fluctuations are dwarfed by the long-term value created over years and decades of distributing cash flow to investors and reinvesting cash flows in the business.

The following graph shows the S&P 500 index since 1928. Over this time frame that spans nearly a century, the market has moved consistently higher.

Market Fluctuations Are Temporary – But Still Painful:

While the long-term trend of the market is up, the truth is that the long-term growth is often interrupted by sharp and painful spirals that often feel out of control and are sparked by frightening events and fueled by extreme media reporting.

Zooming into the graph above demonstrates how painful some of these market downturns can be.

Periods like the Dot Com bubble of the early 2000s and the Great Recession of 2008 and 2009 can test the resolve of the most seasoned investors.

Those who are successful over the long term know that short-term challenges will arise and are prepared to ride them out when they occur.

They understand that the underlying current of earnings and cash flows creates a strong pull forward despite the occasional headwind that may push them backward from time to time. They also realize they cannot predict the headwinds with any accuracy; so standing on the shore hoping to guess exactly when the headwinds will start and stop is the quickest way to let the current pass you by.

Preparation Works – Predictions Don’t:

While the financial media makes their money by publishing stories and opinions by “experts” who have the inside scoop on the market, the truth is that no one knows what will happen in the short run.

Although large market fluctuations, including recessions, are sure to happen regularly over the years, the idea that they can be anticipated and predicted has been proven wrong time after time.

While timing the market seems like a simple proposition because there are only two options – being in the market or out of the market – the reality is that markets are unendingly complex and are influenced by countless variables that often interact together in ways that cannot be anticipated.

Whether it is the psychological influences from human behavior, unforeseen economic news, government regulation, foreign tensions, company specific events, or anything else, history has shown that no one has been able to consistently predict short-term market movements.

Market timing has been the subject of significant research. In a paper published in 2016 , Wim Antoons and the Brandes Institute focused specifically on market timing and concluded that investors are overconfident in their ability to make market timing calls. In nearly every case, market timing approaches underperform buy and hold strategies.

Specifically, the study referenced their review of 68 market timing experts. Forty-two of the 68 were accurate less than 50% of the time and not one was able to make money from their market timing calls after factoring in transaction costs (Antoons, 2016, p9).

While timing the market seems simple, in practice, its results are similar to going to the casino and gambling. It works just enough to keep an individual coming back, but the odds are unfavorable, and over time it is a losing game that can have devastating impacts on long-term results.

Since market timing doesn’t work, the solution is to create an investment plan that can withstand market fluctuations and prepare mentally to wait out the fluctuations when they occur.

Warren Buffett Quote:

“The only value of stock forecasters is to make fortune-tellers look good.”

Why Market Predictions Fail:

Predicting market movements is impossible, particularly because a large portion of market returns come in short periods of time. Individuals who are not invested on those specific time periods will see their long-term returns decimated.

Consider the following graph showing the S&P 500 index return over the 20-year period from 2005-2024. Remaining fully invested for the entire period would have resulted in an annualized return of 10.4% while missing the 20 best days (i.e. one day for each year in the period), would have reduced that return to 3.5%.

The common argument is that most of the best and worst days come in close proximity; so, if an individual misses the best days, they are also likely to miss the worst days. This argument sounds reasonable at first, but when evaluating actual investor behavior, it falls apart. What typically happens is investors become concerned after the market falls and decide to sell until the uncertainty is resolved, a practice that frequently results in experiencing the bad days and missing out on the soon-to-follow good days.

The following graph demonstrates this fact by showing the investment results for an initial $1,000 investment in the S&P 500 over a 25-year period.

The result on the far left shows the value of the investment assuming no market timing. Each successive bar shows the value of the investment assuming the individual cashes out each time the market drops -2% and waits the corresponding amount of time before reentering.

As is clear from the graphic, selling after market downturns significantly reduces long-term results.

The moral of the story is that remaining fully invested provides the best opportunity for long-term success.

Warren Buffett Quote:

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

Why Predictions Don’t Matter:

When you sit down and talk with people about their goals and values, everyone has dreams they hope to achieve and accomplish. Often these dreams are a comfortable retirement while maintaining their lifestyle. They also may include purchasing a second home, providing for future generations, or leaving a legacy for family.

For each of these objectives, money is a tool and a resource, but it is not the end goal. In most cases with adequate planning, individuals can achieve their dreams by simply participating in the long-term wealth creation generated by owning strong capable businesses year after year. While there are temporary setbacks as markets fluctuate, the long-term upward trajectory of the market dwarfs the short-term downturns.

Over the past 80+ years, the average Bull market (i.e. period of market growth) has lasted 4.3 years and increased 149.5% and the average Bear market (i.e. period of market downturn) has lasted 11.1 months and declined 31.7%.

The following graphic from First Trust shows both the Bull and Bear markets over this time period.

Those who focus on the short-term setbacks have placed their attention in the wrong place. What this chart demonstrates is that it is much more important to participate in the market as it is going up, than to avoid it when it is going down… and the only way to guarantee that you participate while it is going up is to be invested at all times.

The strong Bull markets over the years not only far exceed the losses during Bear markets, but they also provide massive growth that creates the opportunity for nearly all individuals to reach their financial dreams without having to engage in the impossible task of predicting when Bear markets will begin and end.

The Best Investment Strategies Are Rarely Exciting:

While watching markets fluctuate and listening to the financial media would lead most individuals to believe that there is never a dull moment with investing, a well-crafted investment plan is based on principles that remain stable day-to-day and year-to-year.

While there will always be new and exciting investments touted by financial pundits and those who have made significant sums by owning the “new asset” during its meteoric rise, chasing the current investment that is dominating the news cycle frequently leads to disaster.

The biggest key to long-term investment success is establishing and sticking to a sound investment strategy. Regardless of the investment strategy, there will almost always be a competing opportunity or exciting investment that is performing better. Even the best investors who have incredible long-term track records often have long periods of underperformance.

For example, despite long-term outperformance, value investors have suffered many years of underperformance compared to growth investors. Additionally, there will be periods of time where individuals who are simply holding cash or treasury bonds will outperform those who are holding equities. However, over the long-term, the investors who are successful will be the ones who create a sound investment strategy from the start and maintain the discipline to stick with it for the long term.

Warren Buffett Quote:

“We don’t have to be smarter than the rest. We have to be more disciplined than the rest.”

Conclusion:

For most individuals, the secrets of long-term, successful investing aren’t secrets after all, but just because the principles of success are simple doesn’t mean they are easy. Watching your life savings fluctuate as you are in or approaching retirement can be one of the most frightening feelings you will experience.

It is times like these that a sound investment strategy based on facts rather than emotion and the steady resolve of a qualified advisor can make the difference between calamity and long-term success. If you are interested in learning more about how to create a long-term investment strategy for your family that is prepared for the years ahead, please free to reach out and one of our Family CFOs would love to connect and see if what we do is right for you.

As you prepare for the years ahead, take the principles above to heart and commit to being a long-term investor. Those who do will experience the benefit of knowing the secrets to investment success.

Disclosure: Past performance is not indicative of future results. The S&P 500 Index (“S&P 500”) is a market-capitalization-weighted index consisting of 500 stocks chosen for market size, liquidity, and industry group representation. The results for all indices are obtained from third parties deemed to be reliable, but are note guaranteed. All of the indices are unmanaged and cannot be invested in directly. Results do not reflect fees or other expenses of investing.

References:

1. Wim Antoons (2016). Market Timing: Opportunities and Risks (Number 2016-06). The Brandes Institute. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2983997