Is Time Really an Investor’s Ally?
We’ve all heard it. Some of the most famous financial minds in history have declared it. When it comes to investing, time is your ally. And while we all know how compounding can handsomely grow an investment portfolio over time, how many years does an investor need to commit to receive the potential rewards of patiently waiting? In this blog post, I’ll explore the issue of time.
“The stock market is a highly efficient mechanism for the transfer of wealth from the impatient to the patient.” Warren Buffett
The Minimum Amount of Time
If you want to get rich quick from normal (non-speculative) investing, I have some bad news for you. You’ll likely need to wait at least a decade to be in a position to potentially enjoy meaningful growth of your nest egg. Assuming you have a broadly diversified portfolio comprised of several thousand domestic and international stocks and very high-quality bonds (65% stocks and 35% bonds), you should, based on historical returns, expect to earn somewhere between a 15% compound annual return at the high end and a 2% compound annual return return on the low end. Obviously, that’s a very wide range, but note the bottom of the range is still a positive compound annual return. When we start looking at fewer than 10-years periods in history, we see some very handsome positive returns, but we also see many periods with negative results. So you should be prepared to be fully invested for at least 10 years if you want a very high probability of ending with more money than you had when you started.
Let’s Look at 15-Year, 20-Year, and 25-Year Periods of Time
What happens if you commit your money in a 65/35 portfolio for 15 years? An interesting phenomenon happens when we look at 15-year chunks of time – we see higher lows and lower highs. Whereas 10-year chunks of time have a historical range of compound annual returns between 15% and 2%, 15 year time periods reveal a range of returns (on the same 65/35 portfolio) of about 14% and 5%, high to low. So we see a lower high return in our 15-year range, but we also see a higher low return. I suspect you’re sharp enough to speculate what happens as we move further out along the investing time horizon. The spreads between the highs and the lows continue to compress! The 20-year time frame shows a range of historical returns on a 65/35 portfolio between about 13% and 6%, high to low, while the 25-year time frame spread is about 13% and 8%.
Past Performance Does Not the Future Predict
Historical returns do not guarantee you’ll see similar returns in the future. If you’ve noticed the financial services industry disclaimers, you’re probably familiar with the phrase, “Past performance is not indicative of future results.” But historical returns do provide some useful information. Going back over 87 years to 1932 when some landmark federal legislation was enacted (like the formation of the Securities and Exchange Commission, or the SEC, which made insider trading illegal, etc.**), in our portfolio comprised of 65% in diversified stocks and 35% in high-quality bonds, there has NEVER been a period of negative 10-year returns nor has there been a 25-year period when the compound annual return was lower than about 8%. So, yes, the past does not predict the future, but the chances of your getting stuck with a return less than about 8% on a 65/35 diversified portfolio over a 25-year stretch of time are pretty damn remote. Can it happen? Yes. But you’ll have to paint an Armageddon scenario for me to accept that a negative or a very low return is probable over a few decades. It simply does not reconcile with the historical growth of the American economy or the international developed economies. If you’re managing your portfolio for Armageddon, sell your stocks and bonds and buy food, fuel, and ammunition!
If you are a patient investor, you should take comfort in the high degree of certainty that you’ll be rewarded with a pretty decent compound annual return. If you’re willing to hang in there for two and a half decades, think 8% as the probable worst-case scenario for your 65/35 portfolio. And if you can earn 8% worst case, that means you can double your money about every 9 years. So absent Armageddon, expect to at least triple your money over a 25-year investing time horizon! Not bad, eh?
** Other landmark registration that was enacted in the wake of the 1929 Crash: Securities Act of 1933 before which no company financial disclosures were required, and if disclosures were made, there was no requirement that said disclosures be accurate. For ex., we take it for granted that a co. will issue a 10K and 10Qs, but before the Securities act of 1933, they were not required. Furthermore, underwriters were not liable for inaccurate financial data before an IPO. FDIC was also formed in 1933; Securities Exchange Act of 1934 – SEC was formed; insider trading and mkt manipulation was outlawed; margin requirements increased from as low as 1% to more like 50%; 1940 – Investment Company Act – required daily liquidity at NAV, etc.