In today's world of no-fee discount brokers, real-time alerts, and the 24/7 news cycle, investors can often get lost, confused, and emotional. At its worst, today's financial media encourages investors to take excess action, which is actually one of the worst things one can do in investing. That's because the most important principle in investing is not how savvy your trading chops are, but something quite the opposite: patience.
While professional investors can often get lost in the weeds of earnings results, the next big technology innovation, trade wars, pandemics, or anything else, everyday investors can achieve stunning long-term investing results -- often beating the professionals -- as long as they adhere to a regular investing schedule and practice the principle of patience.
Why is patience the most important principle in investing? Consider the following eye-popping statistics in the examples below.
Time in the market is better than timing the market
While picking individual stocks can be fun, exciting, and give investors the possibility of outsized returns, most investors will do just fine over the long term with either an index fund or diversified exchange-traded fund (ETF) with broad market exposure.
However, more important than picking the exact right type of fund is how early you start investing, especially if you're looking to hit the retirement milestone at age 65 or earlier. This is due to the power of compound interest, which Albert Einstein once referred to as the eighth wonder of the world.
Consider the following example: Two people, Phyllis and Donny, each earn an average 7% return on their investments over the long-term, which is about the average return of the stock market over its history. However, Phyllis and Donny invest different amounts at different times in their lives.
Phyllis starts the earliest, investing $5,000 at the end of each year from the time she is 18 through age 27, but then stops, after investing $50,000. Meanwhile, Donny gets a bit of a late start but invests for three times as long: He invests $5,000 at the end of each year between ages 28 through 57, investing a total of $150,000 over 30 years.
Despite Donny's having invested three times the amount of money as Phyllis, by the time both are 58, Phyllis will have accumulated $600,743, versus Donald's $505,365!
What's the lesson? Even if you don't have much investable cash today, it's important to invest whatever investable dollars you have as early as you can. With the S&P 500 still below its February highs thanks to the COVID-19 pandemic, today still looks like a fine time to begin or add to your long-term market portfolio.
For great individual companies, patience also pays off
Aside from just general market compounding, the miracle of compound interest also works -- in fact, it works even better -- for the very best growth companies. High-quality growth companies often don't pay out much in dividends or even any dividends, but instead reinvest their earnings internally into new business opportunities.
In fact, investment guru Warren Buffett once said that, "When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever." For an active manager like Buffett, who's attempting to outperform the market, saying that he likes to hold a particular stock forever and never sell is quite a statement. And yet, if an investor holds a great company -- even if you think the stock may pull back in the near term -- it's almost always a better idea to be patient and to let the power of internal compounding do its work, as long as the company retains its competitive advantages and quality management.
Consider the example of one of the great compounding growth companies of all time: Amazon.com (NASDAQ:AMZN). If you had invested in Amazon's IPO back in 1997 and held all the way until today, you would have made a stunning 2,000 times your money, turning just $1,000 into $2 million.
Yet even if you thought Amazon had terrific long-term prospects, was run by a business genius in Jeff Bezos, and retained strong competitive advantages over rivals, you might have been tempted to sell many, many times along the way. In fact, during the dot-com bubble, Amazon's stock had risen 50-fold over its IPO price by December of 1999 and had clearly gotten ahead of itself.
"This is a good time to sell," you might have thought. And in the short term, you would have been right. During the dot-com crash between 2000 and 2002, Amazon's stock lost a stunning 90% of its value.
However, if you had just been patient and held shares through those turbulent times, you would have gone on to make 2,000 times your money over the 23 years Amazon has been a public company instead of the (admittedly great) 50 times your money in three years back in 1999. Though you may have been able to sell at the top and get back in near the bottom, precisely timing the near-term movements of an individual stock is basically impossible.
In the long term, patience pays off in investing
As these examples show, whether you make contributions to broad-market funds or high-quality individual stocks, practicing patience can make a huge difference in your long-term returns. That's even truer if you have stocks in a taxable account, as excess trading may not only limit your long-term returns, but also subject you to capital gains taxes along the way.
So remember, contribute regularly to indexes and ETFs, and seek out great companies with fantastic long-term prospects. Then, do the hardest part of all -- nothing!