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The Secret to Being Absolutely Certain You'll Win in Stocks

By Dan Ferris, editor, Extreme Value
Tuesday, August 24, 2010

Last week, I showed you how to master the "loser's game" of investing.
You see, most investors beat themselves. Too impatient to wait for returns to accrue, they fail (by a wide margin) to even match index returns. During the great bull market to end all bull markets from 1984 to 2000, for example, equity mutual fund investors made 2.57% per year. Market index funds returned 12.22% per year.
I learned about mastering the loser's game in Charles Ellis' classic book, Winning the Loser's Game: Timeless Strategies for Successful Investing.
The entire book is a must-read, but I urge you to pay special attention to Chapter 8, called "Time." Ellis writes, "Time is Archimedes' lever in investing." He correctly identifies time as "the single most important factor in any investment program."
If you're focused on the long term, time creates certainty. If you want to be more certain of your expected investment returns – if you want to compound your money at the highest possible rate with the lowest possible risk – mastering time is the key. You must learn to look past short-term noise. Long-term investors must learn to hold stocks for at least 10 years.
In fact, at 10 years, you're only just beginning to achieve certainty. According to Ellis, out of all possible returns for the S&P 500 in all the 10-year holding periods from 1900-2000, there's only one loss. The average annual gain is anywhere from 5% to 15%.
The range of possible inflation-adjusted returns in the S&P 500 for one-year holding periods during the last century is unfathomably wide, from +53.4% to -37.3%. There's no way to predict the potential returns you could make in a given one-year holding period. You lose money almost half the time.
A few years ago, a Morningstar study said the mutual fund industry's average holding period for a stock was just one year. They shouldn't be allowed to call them mutual funds. They should be required to call them gambling pools.
To really use time to create certainty, you need to go out even farther than 10 years. The range of returns for all the 20-year holding periods during the last century contains no losses, only positive returns. The average annual returns range anywhere from 1% to about 12%.
A one-year holding period is purely a gamble. At 10 years, you're an honest-to-goodness investor. At 20 years, you're demonstrating mastery of time. And mastering time is how you win the loser's game.
If you really want to be certain you're not going to lose money, you shouldn't invest in stocks with money you're going to need in less than 10 years. If you can't wait for your returns to arrive, you can't be certain you'll earn them.
As I've said before, waiting is the one thing investors least want to do, so it's the easiest way to gain an advantage over other investors. And the advantage is easier to gain than ever. Back in the 1950s and 1960s, the average holding period was several years. Investors were investors.
Today, most so-called investors are skittish traders. Today, the average holding period for an NYSE-traded stock is just six months. If a one-year holding period is a gamble, a six-month holding period must certainly be a way to light money on fire.
That's why studies consistently find investors only make a few percent a year over the long term – because they're consistently trying to hit one of those positive returns among the huge range of possible returns for short-term holding periods. Since that range includes many negative returns, they're gambling.
You can't predict which way the market will go. The only thing you can do is learn to value businesses and be patient. Be patient for bargains to appear. When you find them, be patient for your returns to accrue.
Good investing,

Further Reading:

Investing in blue-chip, dividend-growing stocks – sticking with those investments long-term – and reinvesting your dividends is the safest way to boost your gains with super low risk. The world's most successful investor, Warren Buffett, grew his $50 billion fortune largely through this strategy. Learn how you can see huge returns with low risk here: Turn $1,000 of Your Kid's Savings Account into $168,700.
If you're looking for a little help buying the right stocks and holding for the long-term, check out Dan's classic "professional help" essay here: How to Instantly Acquire the Knowledge of the World's Most Successful Investors.

Market Notes


As we look around the commodity market this week, we're reminded again why it pays the trader to be a "connoisseur of extremes."
Longtime readers know we're always on the hunt for assets in an "extreme" condition. For example, in December 2008, we wrote a bullish note on crude oil, pointing out the extreme reading in the oil/gold ratio.
Gold and oil tend to respond similarly to economic conditions, but the price between the two occasionally gets extremely out of whack. Thanks to worries about a Great Depression Part II back in 2008, oil sold off heavily. This made it incredibly cheap versus gold.
Oil went on to nearly double in price in the next few months... and turned our recommendation of oil-service stocks into a big winner. But as you can see from today's two-year chart, that oil rally stalled out in the $70-$85-per-barrel range... and the fuel is now struggling below its 200-day moving average, a widely used gauge of whether an asset is in a bull trend or bear trend.
Here's the moral of this story: When you're looking for trading ideas, stick with assets in "extreme" conditions... like extremely oversold and cheap, or extremely overbought and expensive. As this example shows, big gains accumulate in a hurry when things get "less extreme" for a given asset. After that, it's a hard dollar...

Oil skyrocketed off its extreme lows, but has stalled (2-year chart)

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