We often see individual investors get stuck thinking of stocks as short-term trading vehicles. In our opinion, investors who consider themselves owners of companies rather than owners of stocks are more likely to be successful in reaching their goals. As owners, investors should not accept a return on their investment that is less than the risk-free rate plus an equity risk premium. Too often, people invest with long shot hopes of achieving short-term jackpot type returns. They forget the long-term goals of investing – beat inflation and create wealth.
“Companies that generate returns on invested capital greater than its cost of capital are instrumental in achieving long-term wealth for investors. Unfortunately, companies that create wealth eventually attract competition from other companies, ultimately driving down product prices and profit margins.”
“Can investors forego short-term thrill for long-term reward?”
In a rational investment market, investors demand higher returns to compensate for higher risk. Therefore, one should logically expect lower returns from safer securities and higher returns from riskier securities. This has long been one of investing’s fundamental precepts. However, rational is not always an accurate description of investor behavior.
If I lose 20% of my money this year, but I’m up 20% next year, I’m back to even, right?”
At first glance, this may seem correct, but it doesn’t accurately reflect the effect of losses on an investment portfolio. Understanding the difference between arithmetic and geometric returns and how they relate to portfolio value is essential to understanding what volatility means to your long-term investment success.