Posted by: zyxo | January 17, 2016

The long-term investment paradox


For the long term: invest in stocks!

It is a historical fact that in the long run an investment in stocks will give you the highest yield.  From 1950 til 2009 stocks delivered an average return of 7.5%.  The average for the last 100 years is 9.4%.  Which means that if you have money that you do not need shortly, you should invest it in stocks.  (but be aware of the fact that returns from the past say nothing about the future!)

What is a long term?

History shows that if you can wait 19 years or more, with stocks you will never have a negative return.

Consequently you find this recommendation all over the internet: invest for the long term in stocks, buy and hold.

Let’s do it!

OK.   You invest in a portfolio of stocks that money that you only need let’s say 20 years from here.  Forget about it and live your life for 20 years.  Than come back, look at your portfolio and triumph: there is your money waiting with probably a lot of extra return.

So where’s the catch?

There is no catch if you indeed forget about it and live you life for 20 years.

But what if you don’t?

What if you take a look after 15 years in stead of after 20 years?  Then there is this situation: you look at your portfolio, and very likely you will triumph: there is your money waiting with probably a lot of extra return.

So what?

Well, the situation really is a paradox: if after the 15-year-observation you do nothing, you actually decide at that point in time to put/leave your investments for a relatively short time (5 years) entirely invested in stocks! Just by looking at it, you change your investment horizon.  In stead of posessing a portfolio with an investment horizon of 20 years, you changed it to 5 years!

(compare this with the observation effect in quantumphysics: the mere fact of observing changes the reality   (or see the double slit experiment)

Then what should you do?

There are two options: “observe” versus “do not observe”.

The simplest is doing nothing.  Just wait for 20 years and then grab what is waiting for you. Period.  But if you are an investor, can you really wait for 20 years without knowing what happens? I don’t think so.

The other thing is, yes, to observe.  And while you observe, you see 2 things happen:

  • first: you see the movements of your investments. Up… down… up… down… down… up… etc. in a very erratic way, and hopefully more up than down.
  • second: in the same time you see, very steadily, shorten your investment horizon, which implies a gradually growing uncertainty of the outcome.

My advice:

You should begin by setting your goal, for example a very acceptable 5% annual return (can be anything, but the higher your expectations, the lower the probability that they will materialize).   Then you invest (all at once, or gradually spread over one or two years, whatever you like). Therafter you wait and observe.  If your goal was 5% a year, which means a total gain of 165.33% after 20 years (compound interest) what you should do is simple: say your investment goes up and the moment it reaches this gain of 165.33% : SELL and get out.  You already have what you wanted and moreover you eliminated all risk.  It does not matter whether this occurs after 5, 10 or 15 years.

In short: three steps, two possibilities

Step 1. fix your goal, which is an annual return, but calculate the corresponding total value at the end of your investment horizon.

Step 2. invest and observe

Step 3. possibility 1: at some moment your investment reaches your target total value: sell and get out,
or possibility 2: your investment never reaches your target total value, so at the end of your investment horizon, sell and get out with what you have.

 


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