A Dying Art

Berkshire Hathaway stock could decline by more than 99% and still have a performance track record that beats the S&P 500 since 1965.

The lesson is simple: a small compounding edge over a long time makes a world of difference.

Warren Buffett has the famous quote his favorite holding period is forever. He first purchased shares in Coca-Cola in 1988 and still holds them today. To the best of his ability, he puts his words into practice.

The phrase often repeated around holding periods is “invest for the long term.” In a year like last, we heard it more than usual. If the phrase charged residuals, it would perhaps be as lucrative as Seinfeld or Friends re-runs.

While easy to say, it’s difficult to put into practice.

According to JP Morgan estimates, fundamental investors account for only 10% of trading volume in stocks. Fundamental investors are generally defined as those buying and selling stocks based on their views of a business and its future prospects. This means most of the trading volume in stocks comes from passive investors (mostly buying exchange traded funds) and quantitative investors that base investing decisions on computer formulas.

Average holding periods among investors has been shrinking for decades. Data from the New York Stock Exchange shows the average holding period for stocks was approximately eight years in 1960. Today, the average holding period is roughly six months.

There are many reasons for this. The rise of electronic trading, emergence of high-frequency trading, no commissions trading, and a smaller pool of available public companies to name a few.

This means long-term, fundamental value investors willing to endure short-term volatility in pursuit of long-term returns are increasingly rare; almost like being a practitioner of a dying art.

There’s an interesting analogy from the movie Bull Durham where Kevin Costner plays an aging catcher, Crash Davis, signed to mentor and develop a young player, Nuke LaLoosh (played by Tim Robbins), to help him achieve his goal of getting to the major leagues.

Costner summarizes the difference to Tim Robbins character between major league players and minor league players:

"Know what the difference between hitting .250 and .300 is? It's 25 hits. 25 hits in 500 at bats is 50 points. There's 6 months in a season, that's about 25 weeks. That means if you get just one extra flare a week - just one - a gorp ... you get a groundball with eyes ... you get a dying quail, just one more dying quail a week... and you're in Yankee Stadium."

In short, the margin for error is extremely thin. The difference between playing in Yankee Stadium and traveling on coach buses between small towns could be 25 hits over six months.

Investing presents a similar parallel. The difference between achieving good versus bad returns can boil down to a few decisions made over an investing lifetime.

Whether it’s hitting a groundball with eyes or achieving successful investment results, we must acknowledge there’s an element of luck involved. For example, if your biggest contributions to an investment portfolio were in the 2010’s decade that was significantly luckier than doing so in the 2000s, a “lost decade” that was book ended by recessions.

But it’s also true you can create your own luck in certain ways. For investors, there are few obvious examples: spreading out your risk (diversification), not trying to beat the market (most investors underperform the market), contributing to a portfolio during corrections and bear markets, and recognizing patience is a significant advantage over other market participants.

For the average investor, it’s surprisingly simple to do well with a long-time horizon. Simple, but not easy. Consistent habits practiced often are small edges. Over time, small edges become big edges.

If you’re investing for 30 years, the biggest gains in dollar terms are going to come in the last couple of years of the investing cycle. That’s how the math of compounding works; it gets exponentially higher as time goes on.

Similar to Berkshire’s long-term compounding advantage versus the S&P; Buffett’s net worth followed a similar trajectory. More than 99% of Buffett’s net worth was created after he turned 52 years old.

Reasonable returns over long periods are much more beneficial than incredible returns over short periods.

Long-term investing will never be easy – markets are always climbing a wall of worry – but it remains the best course of action for the vast majority of investors.