Reaching The Long Run

Everyone claims to be a long-term investor, but few truly reach the long run — For compounding, time is more important than rate of return — Too often, investors are forced to sell.

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REACHING THE LONG-RUN

Realizing the exponential rewards of compound interest requires two inputs: a high rate of return and time.

While 99% of investment advice focuses on identifying businesses capable of delivering high returns, little attention is paid to the critical role of time. In theory, time is simple: you just wait. In practice, maintaining investments over decades is far more challenging.

Knowable Barriers

Young investors are envied for the time they have ahead. A 20-year-old can buy and hold, compounding their capital for 45 years until a peaceful retirement at 65. Plugging in an 8% annual return over 45 years transforms $1,000 into approximately $32,000, demonstrating the power of compounding.

But life’s demands tend to get in the way. Weddings, home purchases, and children often require dipping into investment principal. These expenses can be planned for, but interrupt compounding by requiring investments to be sold.

Often young investors explicitly save for expenses, not retirement, investing money to earn a return for a down payment on a house, a car, or wedding. With these events typically less than a decade into the future, these investments will never approach the long-term.

Unknowable Barriers

Even for investors with a multi-decade outlook, unknowable issues can interrupt compounding. Chance not only impacts investment performance but also the hold period an individual can maintain.

Life does not always go as planned. A parent’s illness, sibling moving in, job change, or a natural disaster can disrupt even the best laid financial plans. To mitigate this risk, individuals must maintain sufficient, liquid emergency funds, but this requirement limits the amount of investable capital.

Even with the miracle of compounding, investing $1,000 over 45 years won’t fund a retirement. But investing more, and trading off a sufficiently large emergency fund, will result in forced selling and disrupt the compounding required to hit savings goals.

Mental Barriers

It is easy to believe that fortitude is all that is required to hold investments through market drawdowns. Investors imagine themselves remaining steadfast through catastrophic market declines, emotionally insulated from broader panic. 

Yet it seems that every 20 years markets experience harrowing drops, temporarily erasing hard-earned capital gains. The ability to hold through difficult times is easy to imagine in bull markets, but watching a college fund vanish or fearing for one’s job while a retirement fund evaporates can overwhelm even the most committed investor.

Downturns are extreme not just due to macroeconomic conditions but because they force investors to sell against their will, regardless of their prior commitment to hold.

Institutional Barriers

Even institutional investors, such as endowments with theoretically infinite timelines, struggle to maintain long-term holdings.

Many endowments committed heavily to alternative investments, only to face disruptions from changes in donation levels, potential endowment taxes, and slowing distributions. These events force secondary sales, incurring losses and transaction fees while interrupting compounding.

Additionally, alternative investments like private equity often have built-in exits every 5–7 years, passing ownership to another party and further breaking the compounding cycle.

Reaching The Long Run

Warren Buffett’s extraordinary wealth stems not only from his stock selection genius but also from his incredibly long hold periods. By refusing to sell his stake in Berkshire Hathaway, Buffett protected his capital for the long run.

Any investor able to hold an investment for sixty years has the opportunity to build incredible wealth, but as we’ve seen, life changes, macroeconomic or geopolitical events, and market volatility often spoil this opportunity. In our next post we’ll explore the secret behind reaching the long run, namely converting money into investment capital.