Beware This Investing Advice

Buying and then holding a broad stock market index (for years on end, or even decades) is often given as sensible advice for investors. And why not?

In the U.S.A, there has never been a rolling 20-year period between 1871 and 2012 where an investor had lost money (after accounting for reinvested dividends and adjusting for inflation) by buying-and-holding the S&P 500 (a broad market index in the country) for two decades. You can see this clearly in the chart below, produced by my colleague Morgan Housel:

S&P500 long-term returns

Coming to home in Singapore, I don’t have that much data to work with, but I once looked at how the Straits Times Index (SGX: ^STI) would have rewarded investors if I measured returns at the start of every month from the beginning of 1988 to August 2013. If the index was held for a year, investors would have a 59% chance of sitting on a positive return (I did not include the effects of inflation nor adjust for reinvested dividends – it’s plausible that the effects of both would more or less cancel each other out over the long-term, though); if that holding period was stretched to 20 years, there were no losses.

Given such a record for how market indexes have performed over the long-term, this whole “buy-and-hold” thing really does seem to make sense.

But here’s something to upend things in a major way. The Nikkei 225 (Japan’s rough equivalent for the Straits Times Index in Singapore) peaked at more than 38,900 points at the end of 1989; today, after close to 25 years, the Nikkei is still down by more than half at 17,900 (this does not include the effects of reinvesting for dividends). Has long-term buy-and-hold failed? Shouldn’t investors beware investing advice that advocates for long-term investing given such an experience in Japan?

Turns out, there’s an important caveat to long-term investing, and that is, valuations must make sense. Near its peak, the Nikkei carried a price/earnings (PE) ratio of around 100; that’s an absurd valuation which almost guarantees a poor outcome for the investor of a broad market index.

This might naturally raise the following question for investors who want to invest for the long-term: Is Singapore’s share market absurdly valued now? Before I answer, do note that no one can give you a precise response; but fortunately, to paraphrase investing great Benjamin Graham, you don’t really have to know the weight of an obese man to know he’s fat.

At the moment, the SPDR STI ETF (SGX: ES3), an exchange-traded fund which closely tracks the Straits Times Index, has a PE ratio of 13.5. This compares against the Straits Times Index’s long-term average PE of 16.6 stretching from 1993 to 2012. So, it’s highly likely that we’re nowhere near “absurd valuations” in any meaningful way.

A Fool’s Take

Buying-and-holding for the long-term works great for investors because, as investor Nick Murray once quipped, “Time in the market is your greatest natural advantage.” But that said, investors should still be aware of valuations in the broader market because extreme-bubble situations can hurt even the long-term investor, as we saw in Japan.

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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 doesn't own shares in any company mentioned.