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Your Last Remaining Edge on Wall Street


Wall Street's edge over you seems to tighten by the hour. Insider trading is rampant. High-frequency traders can see your trades before they're even executed. CNBC reported last week that Thompson Reuters sells the results of consumer confidence reports to select professional investors as little as half a second before the data is made public -- that's all they need to gain an edge. 

"Why shouldn't I just give up?" a reader emailed me last week.

I'll tell you why.

Individual investors have a giant advantage over professional investors, and they might not even know it.

What is it? Time. 

You're trying to fund your retirement over the next 20 years. Hedge fund managers have to woo their clients every month. You're saving for your kids' education next decade. Mutual fund managers have to fret about the next quarter. You can look years down the road. Traders have to worry about the next ten milliseconds.

Most professional investors can't focus on the long run even if they want to. As Henry Blodget put it:

If you talk to a lot of investment managers, the practical reality is they're thinking about the next week, possibly the next month or quarter. There isn't a time horizon; it's how are you doing now, relative to your competitors. You really only have ninety days to be right, and if you're wrong within ninety days, your clients begin to fire you.

I'm a long-term investor. I'm not going to fire myself because of a bad quarter. The fact that you and I don't have to play these insane short-term games is the last remaining edge we have over Wall Street. And frankly, it's enormous.

The biggest risk investors face is losing money between now and whenever they'll need it (retirement, school, etc.). The good news for you -- and bad news for Wall Street -- is that the odds of losing money drops precipitously the longer you're invested for.

I took monthly S&P 500 (SNPINDEX: ^GSPC  ) prices going back to 1871, adjusted them for inflation an dividends, and looked at returns based on various holding periods.

Holding stocks for less than a year amounts to little more than flipping a coin. You are almost as likely to lose as you are to win.

But the odds of success grow perfectly with time. If you hold for five, 10, 15 years or more, the odds of earning a positive return on stocks after inflation quickly approach 100%, historically.This chart shows the percentage of holding periods that generated positive returns:

Source: Robert Shiller, author's calculations. 1-day returns since 1930, via S&P Capital IQ.

The irony is that while Wall Street has more information than you, its short time horizon forces it to deal with more randomness than you have to. That's your edge. And it's why any bumpkin who buys an index fund and forgets about it will beat the vast majority of professional money managers over time. 

Here's another way to look at this. This chart shows the maximum and minimum annual returns someone would have earned between 1871 and 2012 based on different holding periods:

Source: Robert Shiller, author's calculations.

Hold stocks for a year (Wall Street's territory) and you're at the mercy of the market's madness -- maybe a huge up year, or maybe a devastating loss. Five years, and you're doing better. Ten years, and there's a good chance you'll be sitting on positive annual returns. Hold them for 20, 30, or 50 years, and there has never been a period in history when stocks produced an average annual loss. In fact, the worst you've done over any 30-year period in history is increased your money two-and-a-half fold after inflation. Wall Street would love to think about those numbers. Alas, it's busy chasing its monthly benchmarks. 

You have the opportunity to focus on the long term. The question is, Will you?

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics. 

Read/Post Comments (3) | Recommend This Article (26)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 06, 2014, at 5:20 PM, captainccs wrote:

    Beware the complacency of long term holding. No matter how long you hold Enron, for example, it will never make a profit for you. The statistics TMFHousel presents are valid for indexes but not necessarily for individual holdings or even for concentrated portfolios. Also, the unexpected need for cash can throw an otherwise well designed portfolio into a shambles. Your best protection is buying at a good price.

  • Report this Comment On December 14, 2015, at 2:57 PM, RodgerKing wrote:

    This analysis take in to consideration inflation and dividends. Another advantage of holding for 30 years or more is that you never have to pay any taxes (except for the tax on the dividends). When you die, your relatives receive a new stepped-up basis and you cheat the tax man. Of course you have to die, but that will happen anyway.

  • Report this Comment On December 16, 2015, at 1:20 PM, drborst wrote:

    Morgan, is the title correct? ...'Total Real Returns' sounds like total returns to me, not annualized.

    Also, Did the S&P 500 lose only 38% in 2008 (or in 1929, or maybe 1930). I lost more than than on my index funds in 2008 (and I know it wasn't the fees). Is it because added over the year instead of buying it all on Jan 1 that I calculated my lose at a lot more than -38%?

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