Ask most brokers, financial planners or other investing “experts” about buying shares and you will receive a similar refrain — something like “you can’t go wrong buying [insert blue chip stock] for the long term.”

The elegance of such advice (for the financial adviser) should not be understated. First, it provides some sort of implicit expertise to the client, second, it diminishes the concept of “risk” attaching to the risky asset (which leads to a purchase and of course, commission) and finally, by the time the statement is proved wrong, chances are the adviser won’t be on the scene anyway.

This is not a general criticism of a “long-term” investment horizon. As Warren Buffett has noted, a long-term strategy significantly increases shareholder returns by avoiding costs such as taxation (which is paid when a share is sold and deferred until then) and incidental selling costs. Rather, it is a criticism of the notion of the “long-term” being some sort of panacea to all investing ills — not all shares simply go up in the “long term” in real terms (remember, any investment needs to be compared against inflation, the nominal rate of return on an investment is of little relevance).

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The recent sharemarket collapse has proven the folly of the ‘you’ll be fine in the long-run’ crowd. In the last twenty years, the Dow Jones index, a measure of thirty large US stocks, has increased at a rate of around 6.7% annually (before dividends and inflation, which would lead to a slightly lower ‘real’ return). Since 1998, the Dow Jones has actually dropped. Such returns aren’t unprecedented — after peaking at 343 in 1929, it took the Dow another 25 years to return to recover to that level. The United Kingdom hasn’t increased in the last eight years while “long-term” investors in Japan have had it especially tough. Since 1989, the Nikkei has dropped by around 80%. In the past nearly 30 years, the Nikkei has increased at all — the long term in Japan certainly hasn’t brought much joy.

While a “buy and hold” investment strategy will usually outperform a speculative, short-term, market timing strategy, that is not to say such strategies are certain to provide strong returns. Shares don’t always rise, in real terms, over longer-periods. A “long-term” portfolio which included Centro, Babcock & Brown, MFS, ABC Learning Centres and Allco (and which wouldn’t have been beyond the realm of being recommended by financial advisers two years ago) would not have been lucrative.

Many companies with strong management and solid return-on-equity perform well over longer investment horizons — but beware of the financial adviser earning commissions for a “buy and hold” strategy. A long-term investing strategy does not completely allay risk, but rather, delays the realisation of losses. Investors should consider the long term earnings potential of a company and macro-economic factors when choosing to invest — despite what some financial advisors may claim, not all ducklings become swans, even in the “long-term”.


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Peter Fray
Peter Fray
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