Investing in stocks has long been considered a strategy for building wealth over time. Traditionally, the approach to stock investment was driven by the philosophy of long-term holding, aligning with the belief that markets tend to reward patient investors. However, recent trends in both Canadian and US markets reveal a stark shift in investor behavior, characterized by a significant decrease in the average holding time of stocks. This shift raises concerns about the implications for long-term investing and the potential missed opportunities for substantial future gains. Let’s start by looking at the trend of typical stock holding periods, and how that aligns with (or contradicts rather) the premise of long term investing.
The Decline in Average Holding Time
Historically, stockholding periods were measured in years, often exceeding a decade. In the 1960s, the average holding time for stocks in the US market was around eight years. By the early 2000s, this average had dropped to approximately five years. As of recent data, the average holding time has plummeted to less than one year. According to an analysis of New York Stock Exchange (NYSE) data conducted by Reuters, the average US investor holds shares for 5.5 months. The analysis also revealed that the average stock holding period has been trending shorter and shorter. The Canadian market exhibits a similar trend, with average holding times also decreasing over time to an average holding period of approximately 6 months currently. Several factors contribute to this trend, including technological advancements that facilitate rapid trading, the rise of algorithmic trading, and a shift in investor mentality towards short-term gains. I can attest to my Interactive Brokers account making it VERY easy, cheap, and fast to trade stocks.
Implications for Long-Term Investing
The decline in average holding time is at odds with the foundational principles of long-term investing. Legendary investor Warren Buffett famously quipped, "The stock market is designed to transfer money from the Active to the Patient." The underlying premise here is that companies often require time to fully realize their growth potential, and investors who exit their positions prematurely may miss out on significant future gains.
Selling Too Early
Short-term holding periods increase the likelihood of investors selling stocks too early, before the companies can fully capitalize on their growth strategies and potential earnings. This tendency can be detrimental, as it prevents investors from benefiting from the compound growth that typically materializes over longer time horizons. For instance, had investors in companies like Apple or Amazon sold their stocks within the first few years of purchase back in the mid 2000s (or even 1990s), they would have missed out on the exponential growth that followed in subsequent decades.
Inadequate Time for Value Realization
Holding great companies for too short a period also means that investors might not allow sufficient time for the market to recognize and price in the future projected earnings and positive economics of a growing business. Growth stories take time to unfold; new product lines, market expansions, and innovative technologies often require years before their full financial impacts are reflected in the company's stock price. These often provide fantastic value investment opportunities before forward financial projections are realised.
The Long-Term Perspective
Despite the trend towards shorter holding periods, there remains a strong case for long-term investing. Historical data consistently shows that stocks held over longer periods tend to provide superior returns compared to those traded frequently. Long-term investors benefit from the compounding effect, reduced transaction costs, and lower tax implications, which collectively enhance overall returns. Investors who adopt a long-term perspective are better positioned to weather market volatility and capitalize on the upward trajectory of fundamentally sound companies. By holding onto investments through market cycles, these investors can achieve the dual benefits of capital appreciation and dividend income, contributing to sustained wealth generation.
The gradual decline in the average holding time of stocks in Canadian and US markets highlights a significant shift in investor behavior. While the allure of short-term gains and the ease of rapid trading have contributed to this trend, it stands in contrast to the principles of long-term investing. Investors who succumb to the temptation of frequent trading risk missing out on the substantial benefits of holding quality stocks over extended periods. To truly harness the wealth-building potential of the stock market, a return to the patient, long-term investment approach is imperative. This strategy not only aligns with the historical success of market investments but also ensures that investors can fully capitalize on the growth and earnings potential of their chosen companies. This strategy also aligns with the one promoted on this MakeCents blog!
A follow up lesson will be posted on the implications that stock holding periods have on capital gains taxation. Stay tuned!