“Whether you’re excited or nervous when your favorite asset falls in price marks whether you’re investing or merely speculating.” – Naval Ravikant (Founder of AngelList)
Are you investing or merely speculating?
Naval Ravikant had an interesting take on this most important of questions. The deciding factor: whether you’re “excited” or “nervous” to see your investment going down in price.
Why would anyone ever be excited to see something they own moving lower?
Because it is giving them the opportunity to reinvest interest/dividends and add new capital at discounted prices. If you have a long enough time horizon and a diversified portfolio, buying at lower prices will increase your long-term return potential. Which is why a stock market crash is actually the best thing that could happen to young investors.
How do you know if your time horizon is “long enough?”
Examine the odds…
Holding stocks for a day or a week is not much better than a coin flip (only positive 53/57% of the time). If that’s your time frame, you don’t have the luxury of waiting for stocks to come back and any decline should make you nervous.
In contrast, holding stocks for 20-30 years has never yielded a negative return, even for investors who bought at the peak in 1929 and held throughout the Great Depression. Given those odds, long-term investors should be excited when stocks go on sale – and the earlier the sale, the better.
The evidence is incontrovertible: the big money in investing is made not in the short-term wiggles but in the big moves, which only come with patience and time. The longer your holding period, the more time you have to compound, and the higher your prospective returns…
That’s not to say that short-term trading can’t be profitable at times, with the potential for outsized gains. The S&P 500 was up 17% in its best trading day ever. But if you happened to time such a trade perfectly, luck – not skill – was the most likely driver.
The real skill? Saving and investing for long enough to minimize the role of luck in the final outcome. This, unlike fortuitous short-term gains, is a repeatable process.
One appeal of short-term trading is the notion that losses are truncated. This is generally true, but only up to a point. The worst day in stocks (-20%) is far lower than the worst month (-43%) or worst year (-71%). But at the 5-year mark, this trend begins to reverse course, and by 20 years the worst return was actually positive.
The worst 30-year rolling return in the S&P 500? +559% – which equates to an annualized total return of 6.5%. And this occurred in a period that included the Great Depression and World War II. The lesson: by increasing your holding period to decades instead of days, you can actually reduce your risk of a bad outcome.
The next time the stock market has a large decline, check your emotions. Are you excited or nervous?
The answer will tell you if you are investing or merely speculating.
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Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. For our full disclosures, click here.