You may be a strong believer of the buy-and-hold strategy and an admirer of the world’s richest investor, Warren Buffett.
If you ask him when it is a good time to sell a stock, he will tell you almost never!
So, what is the real reason that you should hold stocks for a long time rather than trading in the short term?
John Bogle, the founder of Vanguard Funds, studied the volatility of stocks in both near term and long term. From his book, Common Sense on Mutual Funds (a book that I highly recommended), he used a common statistics tool known as the standard deviation to measure the volatility of stocks. A volatile stock means that its price has wide fluctuations. Thus, it would have a higher standard deviation value.
The standard deviation is taken on annual returns from the stock market. The important finding is that as more years are taken into account, the standard deviation or volatility of the stocks decreases. A one-year standard deviation is 18.1%, decreases to 7.5% over 5 years, and further decreases to 4.4% over 10 years.
Over 50 years, the standard deviation is merely 1%! In his words, “The longer the time horizon, the less the variability in average annual returns.” This means that you can expect your stocks to be more stable in price as you hold it longer – your chances of losing money is lowered.Some may argue that your chances of gaining a higher return is also lowered since the price does not fluctuate much in long term view. It is true that the expected range of return is also lowered but one must not forget that through the years, the effect of compounding is tremendous. You can learn about compound interest here.
In summary, by holding stocks for the long run, the risk is minimized and on the upside, let compound interest work for your high returns.
Do your sums and think about it. Play the winning game.
mymoneyblog also shares the same sentiment and he further elaborated that there are 3 sources of long term stock market return = Earnings Growth + Dividend Yield + Speculative Return. Read more about it here.
You may also like:
- 5 Factors affecting the Price of Warrants
- Albert Einstein – "The greatest invention of all time was compound interest."
- Common Stocks and Uncommon Profits by Philip Fisher
- Time Value of Money
- Why investing in mutual funds or unit trusts may not be a good idea?
- What are Bonds?
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Nice one! I love the quote from Warren Buffett that when a person asks him when is the best time to sell a stock, the answer is Never!
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