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The True “Secret Sauce” To Great Investing Returns

top secret pen clipping

It’s no real secret to know that 83 year-old investor Warren Buffett has a net worth of US$63.4 billion today. But did you know that US$59.7 billion of his net worth came after he turned 50, and US$57 billion was added after he was 60?

This is a testament to the effects that compounding has on a person’s wealth over the long-term.

The bulk of Buffett’s net worth is tied up in shares of his US$315 billion conglomerate Berkshire Hathaway. Between 1965 and 2013, Buffett grew Berkshire’s book value at a compounded annual rate of 19.7%.

An investor who’s 20 currently and willing to work hard to find bargains might not be as great as Buffett, so let’s notch down his returns to say 12% per year. With an initial capital of just S$1,000 and without any added funds, his returns would have been somewhat pitiful in the initial years – S$112 in the first year, S$113.44 in the second year and so forth. In fact, even after compounding for 20 years at 12% per year, his capital of S$1,000 would have become ‘only’ S$9,646.

But, what happens if you stretch the compounding period to 50 years? The investor’s S$1,000 investment would have become a six­-figure portfolio – or S$289,000 to be exact. With inflation in Singapore clocking in between 2% and 3% historically, that six-figure sum would still allow for some substantial spending even after 50 years.

Allowing time to work its magic

Investors often clamour for strategies and hot tips to improve their investment performance, but it’s my opinion that one of the simplest (and most effective) tools an investor has at his disposal is often rarely discussed: Adopting a long time horizon.

As my colleague John Maxfield recently wrote (emphasis mine):

“The key to Buffett’s success is not simply the fact that he identifies outstanding companies. It’s also not only because he chooses the most opportune time to invest in them. Indeed, these abilities would be worth little without the temperament to allow time and the law of compounding returns to fully monetize them.”

Trading kills returns

The downside to not investing for the long term is aptly summarised by the research paper “Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors.” I’ve written about it previously, and the following was my takeaway regarding the results of the paper:

“[The study] found that between 1991 and 1996, individual investors who traded the most underperformed the market by 6.5% annually!”

The harmful effects of over-trading aren’t just unique to ‘amateur’ individual investors. Even professional money managers can do well to adopt a long term mind-set.

Some eight years ago on Jan 2006, Louis Lowenstein, a professor from the Columbia Business School, published an essay titled “Journey Into the Whirlwind: Graham-and-Doddsville Revisited.” In it, he wrote about the difference in returns between two groups of funds.

The first group held their shares for an average of five months and generated returns of 8.1% per year for the decade ended August 2005. The second group meanwhile, had an average holding period of 1.6 years for their shares and managed to snag returns of 13.1% in the same period.

A difference of 5.0% (13.1% versus 8.1%) per year for 10 years adds up to a huge difference in returns. For a $10,000 initial investment, it’s the gulf between an ending sum of $34,250 and $21,790.

The benefits of time

There truly are many other benefits to letting time be on our side in investing. One point I often bring across is how lengthening our holding period in shares can dramatically reduce the odds of making losses.

But it’s not just about avoiding losses – it’s also about making a profit. The ability that having a long-holding period can help in achieving the latter was brought home to me by a friend recently:

“More than 36 year ago in 1978, my friend’s mom (let’s call her Mrs Lee) had bought S$1,800 worth of shares in what was then the Singapore Bus Service. In 1980, Mrs Lee bought another chunk of shares in the same company for S$2,000 and has held onto every share since then.

Over the years, through a series of corporate actions, early shareowners of Singapore Bus Service (like Mrs Lee) would have wound up with shares in both ComfortDelGro Corporation Limited (SGX: C52) and SBS Transit Ltd. (SGX: S61) if they had never sold.

And guess what? That S$3,800 investment Mrs Lee had made in 1978 and 1980 has today [as of 7 July 2014], grown to become S$42,300 (as of [7 July 2014], Mrs Lee owns 16,000 shares of ComfortDelGro and 1,200 shares of SBS Transit, all of which came from her initial investments in Singapore Bus Service).”

Foolish Bottom Line

I got the inspiration for the title of this article by a friend who attended the INVEST Fair 2014 over the weekend. He was there to catch a number of speeches, including that of my colleague David Kuo’s (David’s talk has perhaps the cheekiest title for an investing speech yet!).

During one of the speeches, my friend happened to speak to one of the attendees, who seemed curious about how the Motley Fool collects investing information. To my friend, it seemed the attendee thought the Fool might have some “secret sauce”.

I only wish I had been there to tell the attendee that the Fool’s “secret sauce” is really not a secret (and certainly not a sauce!) at all. It’s something simple: It’s the willingness to allow time to be on our side. Because you see, as David wrote in the latest edition of our free weekly investing newsletter, Take Stock Singapore, “here at The Motley Fool Singapore… [we] believe in buying great companies to hold for the long term [emphasis mine].”

To learn more about investing for the long term and to keep up to date on the latest financial and stock news, sign up now for a free subscription to The Motley Fool's weekly investing newsletter, Take Stock Singapore. Also, like us on Facebook to follow our latest hot articles.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Berkshire Hathaway.