Remember when investing was fun? We know — when you look at the returns your growth fund has dished out over the past couple of years, it feels like a lifetime ago. But trust us, investors who have the strength to ride out the rough times will once again view the market as their friend. On a historical basis, that relationship is solid.
Solid, but maybe no longer intoxicating. We're not likely to return to the go-go days of the 1990s anytime soon. Or possibly ever. While the long-term odds offered by the stock market are decidedly in your favor, if you thought investing was easy money — well, you probably don't think that anymore. Looking back on the Internet bubble and the (let's-be-honest) ridiculous money that so many of us made (and lost), it's hard not to wonder "What were we thinking?"
But while the past three years may have taught you that smart investing requires more discipline than you ever imagined, keep in mind that recessions don't last forever. Over the long term, your up years will greatly outnumber your down ones. Consider that before this bear market, the last time S&P 500 had three consecutive years of negative returns was between 1939 and 1941.
So think of it this way: Investing in the new millennium has shaken out the wimps and the fools. And while you may have learned a lesson or two the hard way, there's no reason to think you fall into either of these camps. The wise investor knows this is a marathon, not a sprint.
A Real-World System
The question we've tried to address with SmartMoney University is how you can participate in the ongoing growth of the global economy without taking undue risk. Our answer: A disciplined, long-term approach to equity investing that factors in the occasional and inevitable market crash while holding firm to the belief that the factors driving stocks today will continue to create vast wealth for years to come.
It begins with our own version of the "value" approach -- buying well-researched stocks that are cheap relative to their peers based largely on earnings and earnings growth. It relies on both statistical analysis (derived from the historical behavior of stock prices) and a more subjective look at the factors driving a company's performance -- things like management and competition. Once the picks are made, we advocate the buy-and-hold method of investing as the best way for most people to capitalize on the market's emerging trends.
The logic to a long-term approach is overwhelming:
- Decision making is minimized. Because you're in for the long haul, you don't have to monitor your stocks or funds every minute of every trading day. You do your research initially and trust that unless your fundamental assumptions change, you don't have to worry about short-term volatility — even market crashes.
- Growth is maximized. When you leave your money invested and reinvest the dividends, you take full advantage of the Power of Compounding. That means the bigger your stake gets the faster it grows. Growth in the markets hardly follows a straight line, but history shows that a well-diversified portfolio of stocks will trend upward with the economy and corporate profits over time. (see The Odds Are in Your Favor for more).
- The tax burden is deferred. Returns on stocks held longer than a year are treated as capital gains, which are taxed at the most at the lower 20% rate. And you pay no taxes at all until it's time to liquidate several years up the road.
- Fees and loads don't hurt as much. When you buy stocks or funds and hold them, the brokerage fees and any front-end loads are amortized over a period of years. The cost of heavy trading — even at today's low online rates — can take a big bite out of your profits.
Buy-and-hold isn't short for invest-and-forget-about-it. You do have to monitor your companies and funds to make sure that nothing changes so drastically that you're forced to sell early. You also may want to skim money from stocks you still like to take advantage of an opportunity you like better. Wall Street got humbled in 2000, and in 2001 the economy slipped into a recession. The 2002 economic "recovery," moreover, was as muted as ever. But it's not the first time that's happened. And it won't be the last. Our view is that these occasional periods of market and economic declines present fresh opportunities to buy stocks on the cheap, especially when the long-term macro environment remains so favorable.
Strong growth often begets extreme volatility, making the markets treacherous for short-term investors. But our system — relying as it does on relative value and long-term holdings — is designed to turn volatility to your advantage. The key is to choose the industries with the most promising long-term outlook — telecommunications, networking, aerospace, pharmaceuticals and finance, to name a few — and seek out value within them. We'll provide the building blocks. The rest is up to you.
