Why do people buy stocks?
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Stocks are a proven way to earn money over longer periods of time. Markets may rise and fall but in the end the stock market always rises in value (based on historic data). Be aware that the stock market in general is based on the average performance of all companies in the market. This does not mean individual companies can't go bankrupt.
When we look at the historical annual returns of the S&P 500, you can see a clear trend. The S&P 500 is an index where the 500 biggest companies in the U.S. are tracked based on market capitalization (current price of the share * amount of outstanding shares).
What are annual returns?
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The annual returns that turn out positive are way more frequent than the negatives. The historical return for the S&P 500 from 1926 till 2018 is a whopping 10%. And in the last three years (2019, 2020 and 2021) it’s even a more whopping 15% on average. Where do you get 15% annual returns on your savings? And these last three years even include a world wide pandemic called covid-19. Keep in mind these numbers are not adjusted for inflation yet. After adjusting to inflation the historical return is about 7% on average. But the last ten years have exceeded 10% on average. This does not mean the you'll get the same returns in the future.
That is why ETFs are very populair. An ETF tracks an index like the S&P 500. Whatever the return of the S&P 500, the ETF will have almost the exact same result. Based on the historical data of the S&P 500, and ETF tracking the S&P 500 seems like a solid investment. And an ETF requires zero effort to maintain and additional costs are very low. More on ETFs in chapter 19.
5.1 How long can you hold stocks in your portfolio?
You can hold stocks indefinitely unless the company goes bankrupt. A better question would be how long should you hold stocks? There are various reasons to hold stocks for longer periods of time but many people are short term minded. They panic when a crisis hits and they sell all their stocks. Value investing is something from the long term (10+ years). If you buy a farm this week, you’re not going to sell it a week later. Some famous quotes from Warren Buffet:
Does it matter if you have bought a great house at a great location when the housing market collapses? Not really, you don’t have to sell your house (assuming you don’t have financial troubles). In the same way you don’t have to sell great stocks in a bear market (when prices are plummeting). Your house will continue to provide value for years. And the same thing applies to stocks. But you do need some research before you buy anything.
Why holding stocks for at least ten years is considered a good practice has several reasons:
- Businesses grow slowly over time.
- You can reinvest the dividends for compound interest.
- If you buy and sell stocks each time the market changes you’ll probably lose money.
- Emotions are the biggest factor when becoming a successful investor. If you only buy & hold based on solid fundamentals, you never have to argue with yourself during financially troubling times.
- In the long term, the overall stock market only went up (that does not mean this will always be the case).
But there will be always times these general considerations don't apply. A good example is the covid-19 pandemic. Even the most financially stable airline companies will suffer.
Investing can be done in any time frame you like. But most companies build their business relatively slowly. Just look at behemoths like Apple, Microsoft and Coca Cola. Will the world ever stop drinking Coca Cola or using Microsoft products? Huge companies with large market shares do have the problem of expanding. If everybody in the entire world is already drinking Coca Cola, they can’t grow anymore. So they need to put different brands and products on the market. Like Sprite, Fanta or Coca Cola Zero. Big established companies are more like a certainty for investors. The stocks of these huge companies are also called blue chip stocks.
Be aware that historical returns are no guarantee for the future. Meaning, you can always lose money when investing. Although investing is considered a profitable adventure, most people lose their money.