Because successful investing takes time, discipline and patience.
Warren Buffett is arguably one of the best investors in the world.
From 1965 to 2021, he generated annual returns of 20.1% for his company’s shareholders.
If you had invested just $1,000 in his firm, Berkshire Hathaway, in 1965, you would be sitting on a cool $28.5 million by 2017.
Buffett’s patience in the stock market is one of the key reasons for his incredible return.
He is well-known for holding his stocks for the long run. In fact, he once famously remarked that his favourite holding period in stocks is “forever”.
Yes, Buffett has sold shares often, but it is the thinking behind his quote that matters.
If you have a long time horizon when investing, you will focus on the things that matter (hint: stock prices are not one of them) and will not bother with the things that don’t.
The following is one of Buffett’s well-known quotes:
“Successful investing takes time, discipline and patience. No matter how great the talent or effort, some things just take time: You can’t produce a baby in one month by getting nine women pregnant.”
It requires a considerable amount of time for any business to do well.
By focusing on the long term, we are forced to think about the quality and fundamentals of the company we are investing in.
If we have an “investing” time frame of just one month, we would only be looking at stock price fluctuations alone, and this will be to the detriment of our portfolio.
The daily fluctuation in stock prices will not do any good for our psychological health as well.
However, if our investing time frame is measured in decades or even generations, we will be forced to think about the things that matter: The long-term prospects of a business, the leaders behind a company, the value of a business, and so on.
As prudent investors, we want to invest in companies with products or services that will not become obsolete in the next few years – ideally, we want companies with businesses that can thrive.
Furthermore, when we invest with a long-term view, the probability of us suffering losses will be much lower, which can be seen from the following table:
As you can see, when you hold the S&P 500 index just for a day, it’s 50/50 when it comes to your chance of making money – that’s no better than a coin flip.
However, if your holding period is extended to two decades, the chances of losses go down to zero. Talk about long-term investing and its merits.
Even though the table above refers to the broader stock market, high-quality companies tend to do well over the long run as well.
So the next time you’re looking at a company to invest in, think in terms of years, decades, or generations, and not days, weeks, or months. It’s the mindset that makes a whole lot of difference.
Want to be updated on any new investment articles published by Sudhan? Enter your email address below to subscribe to the blog!
I admit it’s attractive to cherry-pick companies to invest in now with the steep market correction.
But investing in just one company for the foreseeable future is extremely risky in my opinion. While the business can be great, a small mishap from the firm could wipe out an entire portfolio.
Therefore, given the risk of concentrating my portfolio on a single stock, I’m going to diversify my portfolio in an instant with a single investment.
And that investment would be buying an exchange-traded fund (ETF) that tracks the Standard & Poor’s 500 index, more commonly known as the S&P 500 index.
There are plenty of ETFs available that closely track the index’s return, but my pick would be the Vanguard S&P 500 ETF (NYSE: VOO).
Why Is the S&P 500 Index Attractive Now?
For those who may not know, the S&P 500 index consists of around 500 large-cap US companies in leading industries. Such companies include iPhone purveyor Apple (NASDAQ: AAPL), computer software maker Microsoft (NASDAQ: MSFT), and e-commerce retailer Amazon.com (NASDAQ: AMZN).
The S&P 500 index is generally seen as one of the best representations of the stock market as a whole. According to Investopedia, the index has returned a historic annualised average return of around 10.5% from its inception in 1957 to 2021.
To be part of the S&P 500 index, a company must meet some of the following criteria :
It must be a US company;
The market capitalisation must be US$14.6 billion or higher;
It must have positive as-reported earnings in its most recent quarter, and over the most recent four quarters summed up; and
The stock must have adequate liquidity and must trade for a reasonable share price.
The strict entry criteria form a barrier and ensure that investors are getting to invest in some of the best companies out there with relatively low effort.
The S&P 500 is in negative territory, having fallen 12% from a peak of 4,796.56 seen on 3 January 2022. Only last month, it was in bear market mode with a fall of 20%.
A fall of over 10% may sound terrifying, but therein lies the opportunity, if we have a long-term focus.
(Fun fact: A 10% fall in the stock market is a common occurrence.)
Over the short term, anything can happen to the US stock market, but over the long run, history has shown that stocks tend to rise.
During the depths of the Great Financial Crisis (GFC) back in October 2008, famed investor Warren Buffett explained the need to look at the long term in an op-ed for The New York Times entitled, Buy American. I Am. (emphasis is mine):
“Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
Since that op-ed, the S&P 500 index has gone on to rise over 300% to close at 4,210.24 on 10 August 2022. Those who had invested during the GFC would be sitting on juicy returns over the past 13 years or so.
Right now, people are fearful that the inflationary and rising interest rate environment could trigger a recession.
While a recession may happen and stocks could continue languishing before recovering, we should remember that this is not new and that humanity has survived several market crashes previously.
So, “this too shall pass”.
And once the storm is over, stocks should continue climbing higher, as history has shown time and again.
Source: MacroTrends (grey bars show recessions)
Want to be updated on any new investment articles published by Sudhan? Enter your email address below to subscribe to the blog!
Why Vanguard S&P 500 ETF?
I’m choosing the Vanguard S&P 500 ETF to invest in since it has the lowest expense ratio among the S&P 500 ETFs of 0.03%.
The SPDR S&P 500 ETF (NYSE: SPY), which was the very first ETF listed in the US and is the more popular option, has a higher expense ratio of 0.0945%. An ETF’s expense ratio reveals how much investors are paying as fees annually when investing in the ETF.
Bringing down expenses when investing is essential since a fund with high costs will eat into our returns.
Another attractive aspect of the Vanguard S&P 500 ETF is that it allows instant diversification with a single click of the button.
To understand how diversified the ETF is, let’s take a look at the following snapshot showing the fund’s sector composition:
Source: Vanguard
Based on the Global Industry Classification Standard (GICS) sector classification, information technology (at 27.1%) contributes to the bulk of the ETF, followed by healthcare (14.4%), and financials (11.2%).
In terms of specific companies, Apple takes up 6.5% of the pie, followed by Microsoft, and Amazon. The top 10 companies occupy around 26% of the fund.
Source: Vanguard
Now could be a good time to start investing in the Vanguard S&P 500 ETF. According to JP Morgan’s Guide to the Markets (3Q 2022) , the index is selling at a forward price-to-earnings (P/E) ratio of 15.9x, as of 30 June 2022. For the past 32 years, the S&P 500 index’s forward P/E ratio stood at an average of 16.2x. This suggests that the index is fairly valued right now. If its valuation comes down further, investors have the chance to dollar-cost average (DCA) into the ETF, diversifying across time as well.
The Power of Compounding
Since Vanguard S&P 500 ETF’s inception in 2010, the fund has produced an annualised return of 13%.
Source: Vanguard
US$100,000 invested in the Vanguard S&P 500 ETF some 12 years ago would have turned into almost half a million dollars by now. That’s the power of compounding taking effect.
Warren Buffett said in his 2016 Berkshire Hathaway shareholder letter that “investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.”
That’s what I’ll be doing by buying a low-cost fund with Vanguard S&P 500 ETF and sitting on it for the long run to allow the magic of compounding to occur. To add icing to the cake, my overall return could be higher than average as I’ll be investing during a bear market.
Knowing Your Downside
All investments come with risks, and investing in the Vanguard S&P 500 ETF is no exception.
One risk is to do with foreign exchange. Since this ETF is denominated in US dollars, any adverse fluctuations against the US dollars for a Singapore investor could harm the overall returns.
The volatile market condition is something else to take note of.
Stocks in general are subject to wide movements in share price in the short term. That’s what we are experiencing currently. As we discussed earlier, stocks could fall further before they recover, depending on how the economic conditions plays out.
Having said that, we should also understand that volatility is part and parcel of investing in the stock market, and it’s not a bug in the system.
If one is willing to stomach the short-term volatility and stay the course after investing in the ETF, the investor should reap the rewards over the long run.
As author and investor Morgan Housel once mentioned:
“Volatility is the price of admission. The prize inside are superior long-term returns. You have to pay the price to get the returns.”
Want to be updated on any new investment articles published by Sudhan? Enter your email address below to subscribe to the blog!
Disclaimer: This information provided in this article is purely based on my opinions and is not intended to be personalised investment advice. The ideas discussed here are not recommendations to buy/sell any stock.
I would post some of the questions and answers of the topics that I found interesting below.
On the US economy
BECKY: Your annual shareholders letter that you just came out with on Saturday painted a much more optimistic picture of America than many people had been thinking to this point. Why is that? And why are you so positive about things?
BUFFETT: Well, I’ve been optimistic on America right along, as you know. I mean, I was optimistic when I knew things were going to go to hell. But things do – America gets off the track from time to time, and it was particularly so in the fall of 2008. But you can’t stop this country. I mean, we have gone through, I don’t know, 15 recessions, you know, world wars, civil war, you name it. And there is a resiliency to the American system. It does work. And it sputters from time to time. It’ll sputter from time to time in the future, but you don’t want to get too concerned about that. It’s kind of like having a bad crop in farming. If you’ve got some good land here in the Midwest, you’re going to have a bad crop occasionally. But you know you’re going to have mostly good crops and we have great soil for this country, metaphorically. And it works over time
On gold and commodities
BECKY: Well, speaking of gold, though, we’re looking at gold prices and they were at another record high. They’re up another $3 today, $1,434 an ounce. And there have been some big fat hedge fund managers, like a Paulson or a David Einhorn, who have really buckled down on these bids. Why would you steer clear? And do you think what they’re doing is the wrong thing?
BUFFETT: Well, I just don’t know. I don’t know whether cotton’s going to go up.
BECKY: OK.
BUFFETT: I mean, we use a lot of cotton. I’ve watched it go from 80 cents to $1.90. You know, we use a lot of copper and I’ve watched it go from $2 to $4-plus, so I mean there’s all kinds of things in this world that are going to go up and down in price. You know, maybe hamburgers will tomorrow. And – but I – I’m – I don’t know how to judge that. I do know how to judge to some extent the earning power of some businesses. And the real test of whether you would like it as an investment is whether you would be happy if it never got quoted again, and just in terms of what the asset did for you. But that doesn’t – I will say this about gold, if you took all of the gold in the world it would roughly make a cube 67 feet on a side. So if you took all the gold in the world, we could have a cube that went down there 67 feet…
BECKY: Uh-huh.
BUFFETT: …67 feet high and that would be the whole thing. Now for that same cube of gold it would be worth at today’s market prices about $7 trillion. That’s probably about a third of the value of all the stocks in the United States. So you could have a choice of owning a third of all the stocks in the United States or you could have a choice of owning that little block of gold, which can’t do anything but kind of shine there and make you feel like Midas or Croesus or something of the sort. Now, for $7 trillion, there are roughly a billion of farm – acres of farmland in the United States. They’re valued at about $2 1/2 trillion. It’s about half the continental United States, this farmland. You could have all the farmland in the United States, you could have about seven Exxon Mobiles, and you could have $1 trillion of walking around money. And if you offered me the choice of looking at some 67-foot cube of gold and looking at it all day, you know, I mean touching it and fondling it occasionally, you know, and then saying, you know, `Do something for me,’ and it says, `I don’t do anything. I just stand here and look pretty.’ And the alternative to that was to have all the farmland of the country, everything, cotton, corn, soybeans, seven Exxon Mobiles. Just think of that. Add$1 trillion of walking around money. I, you know, maybe call me crazy but I’ll take the farmland and the Exxon Mobiles.
On the US dollar depreciating
JOE: …because, yeah, let’s just wait and I’ll ask him a follow-up to. Because you do get paid back with your investments in dollars. And if those dollars are, you know, are going to be worth much less in the future then I figure you must – you must figure policymakers are going to get it together eventually, Warren, or else, you know, paper money’s not going to be worth anything.
BUFFETT: Well, but that’s true of – if you’re – if you’re trained to be a lawyer or you’re trained to be on cable or anything else you’re going to get paid in dollars. Now, the question is, if you have something valuable to offer even if the dollar gets worth less, you will retain earning power that’s commensurate with purchasing power.
JOE: Ooh.
BUFFETT: And if – I mean, Coca-Cola, the – in the year since I’ve – was born the dollar has depreciated 94 percent. I mean, it’s 16-for-1 in terms of inflation. But if you owned Coca-Cola in 1930, you’ve still done pretty well. Or if you owned a lot of good business in 1930. Because they have the ability to extract real earnings in terms of what they deliver to people. And your doctor is able to charge 16 times as much as in 1930 because his services are still as valuable. So, as the currency gets worth less, it does not make – it does not penalize the service or the good that is really needed by other people. The world adapts.
JOE: Hmm.
BUFFETT: And that’s why I like businesses or I like my own earning power as the best assets in a time of inflation. They really can’t be taken away.
On why he likes private businesses compared to public business
BECKY: All right, the first one, let’s say, comes in from Miykael in Canada, who writes in, “With articles mentioning that you’re looking for major acquisitions, with the economy favoring the low-cost segment, wouldn’t Family Dollar be an ideal fit?”
BUFFETT: Well, there are a lot of companies that would be a fit at a price. It’s easier for us to buy businesses that are privately owned than ones that are trading on the market because people – I don’t care what the market price is in terms of what they’re worth to us. But generally speaking, people, in evaluating mergers and acquisitions, look at the premium pay to the market price and decide whether that’s a fair price or not. A fair price to us is one that – where we think we’re going to get our money’s worth in terms of future earnings, and I would say that we will generally have more luck with private businesses than public businesses, although Burlington was a public company, yeah.
On why businessmen should keep their private businesses
BUFFETT: Well, Mars is a wonderful business, and we’re their partners in Wrigley. And if the Mars family were to ask me about selling their business, I would say keep it.
BECKY: Mm-hmm.
BUFFETT: I mean, if you own a wonderful business in life, the best thing to do is keep it. All you’re going to do is trade your wonderful business for a whole bunch of cash, which isn’t as good as the business, and now you got the problem of investing in other businesses, and you probably paid a tax in between. So my advice to anybody who owns a wonderful business is keep it. Now, sometimes there’s a – some reason in terms of taxes or family situations or whatever it may be that a wonderful business is for sale. But I have told a number of people who’ve come to me who have wonderful businesses, if you can figure out a way to keep it, keep it, because all you’re going to do is take that billion dollars you get, or 5 billion, you’re going to pay some tax on it, now you’re going to go out and buy some stocks, and most of those stocks you buy are not as wonderful as the business that you already owned, and you don’t know as much about it and, you know, so sometimes it pays to know when you’re well off.
On liquidity and savings
BECKY: Yeah, you wrote about that in the annual letter, as well, and said that the thing that you learned coming out of that is the importance of liquidity and not getting over leveraged.
BUFFETT: Yeah. My grandfather left–gave $1,000 eventually, at 10 years after the marriage of each of his children and my aunt didn’t marry, but he gave her $1,000 as well and he sent them this letter and he said, `Put this money away.’ He said, `Don’t get tempted to invest it because some day you may need money and who knows what you’re can do with your investment then.’ So you’ll always want to have some cash. He gave me a $2 bill when I was a kid and he said carry this around and he said you’ll, you know, you’ll never be broke.
Every year, in the Annual Report of Berkshire Hathaway, there’s a section called “Chairman’s Letter” and it’s penned by Warren Buffett himself. It’s a letter for his shareholders and it reveals Warren’s latest thoughts, investment ideas and theories.
I knew about these letters some time back but never really paid attention to them until recently. Three weeks ago, I read a wonderful book called “The Essays of Warren Buffett: Lessons for Corporate America”. The book contains the letters to shareholders from the various years and they are categorized according to different topics for easy read. After reading that book, I realised that I could learn so much from reading the letters alone than reading any other book out there. Most of the books out there on value investing and Warren Buffett are a spin-off off his thoughts revealed in the letters. So, I went to download the letters from the Berkshire Hathaway website, printed them out and got them binded and am reading them now slowly.
The latest 2010 letter was just released yesterday. Catch hold of the letter at http://www.berkshirehathaway.com/letters/2010ltr.pdf now. If you don’t have time to read the whole letter, do read pages 22 and 23. That section is very helpful for our personal finance and also for our investments.
“If I were looking at an insurance company or a paper company, I would put myself in the frame of mind that I had just inherited that company and it was the only asset my family was ever going to own. What would I do with it? What am I thinking about? Who are my competitors? Who are my customers? Go and talk to them. Find out the strengths and weaknesses of this particular company versus other ones” – Warren Buffett
SudhanP.com 