PRACTICAL ASPECTS OF INVESTING
To be a successful long-term investor is easy in principle but difficult in
practice. It is easy in principle because buying and holding a diversified
portfolio of stocks, forgoing any forecasting ability, is available to all in-
vestors, no matter what their intelligence, judgment, or financial status.
Yet it is difficult in practice because we are all vulnerable to emotional
forces that can lead us astray. Tales of those who have quickly achieved
great wealth in the market tempt us to play a game very different from
that of the long-term investor.
Selective memory also pushes us in the wrong direction. Those
who follow the market closely often exclaim: “I knew that stock (or the
market) was going up! If I had only acted on my judgment, I would have
made a mint!” But hindsight plays tricks on our minds. We forget the
doubts we had when we made the decision not to buy. Hindsight can
distort our past experiences and affect our judgment, encouraging us to
play hunches and try to outsmart other investors, who in turn are play-
ing the same game.
For most investors, going down this path leads to disastrous re-
sults. We take far too many risks, our transactions costs are high, and we
often find ourselves giving into the emotions of the moment—pes-
simism when the market is down and optimism when the market is
high. This leads to frustration as our misguided actions result in sub-
stantially lower returns than we could have achieved by just staying in
the market.
GUIDES TO SUCCESSFUL INVESTING
Achieving good returns in stocks requires keeping a long-term focus
and a disciplined investment strategy. The principles enumerated below
are taken from the research described in this book and enable both new
and seasoned investors to better achieve their investing goals.
- Keep your expectations in line with history. Historically stocks have
returned 6.8 percent after inflation over the last two centuries and have
sold at an average P-E ratio of about 15.
A 6.8 percent annual real return, which includes reinvested divi-
dends, will double the purchasing power of your stock portfolio on aver-
age every decade. If inflation stays within the 2 to 3 percent range,
nominal stock returns will range between 9 and 10 percent per year,
which doubles the money value of your stock portfolio every seven to
eight years.
360 PART 5 Building Wealth through Stocks