The Most Important Investing Lesson of All

Good news: There's a secret out there that can make you a better investor. You'll make more money, pay less in taxes, and spend less time stressing about the daily moves of your stocks.

Sounds great, right?

Even better, you already know this little secret. In fact, you learned it in the fourth grade. And despite its simplicity, it can give you a huge advantage over Wall Street pros -- because they all but ignore it.

What is it?

You won't believe how easy it is
The little secret that can truly make you a more successful investor and give you a leg up on Wall Street is an understanding of the principle of compounding. And before you scoff, realize that if all investors understood the principle of compounding, we'd act very differently when it comes to managing our portfolios. For example, we wouldn't:

  1. Check our stock tickers on an hourly, daily, weekly, or even monthly basis.
  2. Pay so much attention to shows like Mad Money that focus on short-term analysis.
  3. Trade more than a few times each year.

It's sad to work in an industry that makes so much money by getting investors addicted to these bad habits. If there's one thing I'd change about the financial services industry, it would be to silence the noise and focus on the numbers.

Alas, that won't happen
But just because the financial industry won't change, it doesn't mean you have to play its game. And I'm not advising you to stop checking in on your stocks; that's part of the fun of investing.

What I am advising, however, is to remain cognizant of the fact that the serious money in the stock market is made by investors who have four things:

  1. Time.
  2. Patience.
  3. A commitment to adding new money on a regular basis.
  4. A portfolio of great stocks.

With those four things in place, you will rarely trade and therefore rarely have to pay transaction costs or taxes on earnings. And because your earnings stay in the stock market, those earnings will have earnings, and those earnings will have earnings, and so on.

A better way
Shelby Davis, a man who was by no means a master stock picker or market timer, amassed a nearly $900 million fortune over his lifetime simply by buying shares of great companies and holding them indefinitely. That's a successful strategy you can replicate.

Let's say, for example, you invested $1,000 in each of the 10 largest public U.S. companies 10 years ago. Here's what you'd own, and what those $1,000 positions would be worth today:

Company

Current Value

General Electric (NYSE: GE  )

$1,673

Microsoft (Nasdaq: MSFT  )

$2,046

ExxonMobil (NYSE: XOM  )

$2,793

Coca-Cola (NYSE: KO  )

$1,088

Intel

$1,296

Merck

$1,293

Altria

$1,766

IBM

$2,065

Procter & Gamble (NYSE: PG  )

$1,955

Bristol-Myers Squibb (NYSE: BMY  )

$594

Total annualized return

5.2%

S&P 500 annualized return

4.6%

This simple, lazy strategy would have helped you beat the market over the past 10 years by buying just 10 stocks and sitting tight. No stress and no taxes; just market-beating results. You also could have done better by adding new money on a regular basis or reinvesting dividends.

The best way
Of course, that lazy strategy barely beat the market. You could have done better by picking even better stocks. And that's where our Motley Fool Stock Advisor investment service may be able to help you. Fool co-founders David and Tom Gardner have made it their mission to identify superior companies that you can buy to hold and hold -- companies that will absolutely crush the market over time. These are companies that are:

  1. Owned by other great investors.
  2. Built to last for 100 years or more.
  3. Little-known, yet dominating growing industries.
  4. Steered by committed management teams.
  5. Governed by the highest corporate values.

If that sounds like the kind of company you'd like to have anchoring your portfolio for the next decade, click here to join Stock Advisor free for 30 days. You can read about all of our recommendations, see our returns, and decide if the principle of compounding can help you make a fortune.

This article was first published on Nov. 21, 2006. It has been updated.

Tim Hanson does not own shares of any company mentioned. Coca-Cola, Intel, and Microsoft are Inside Value recommendations. The Fool's disclosure policy used to do a little, but a little wouldn't do it, so a little got more and more.


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