The journey to becoming a successful long-term investor is often portrayed as straightforward, yet the execution of this journey can prove to be a complex and daunting task. At the heart of discussions surrounding long-term returns on stock investments lies the thorough research conducted by Jeremy Siegel, particularly highlighted in his seminal work, Stocks for the Long Run. This book, revered in investment circles and recently updated for its 30th anniversary, showcases an expansive data analysis tracking asset returns back to 1802 across 21 global markets. Siegel himself regards this latest edition as the most comprehensive to date, earning accolades from renowned investors like Warren Buffett, who calls it an invaluable guide to the stock market.

The essence of long-term investing is encapsulated in a quote from John Maynard Keynes, who once asserted that in the long run, we are all dead. While this idea is irrefutable, it emphasizes the necessity of a long-term vision to guide today's actionable strategies. Those who manage to sustain focus and foresight during turbulent times are the ones who have a greater chance of prospering in the investment landscape. The comforting truth is that after the storm passes, calm will resume at sea, countering Keynes's seemingly bleak perspective.

Investing is easier said than done

The strategic approach of "buying and holding a diversified portfolio without attempting to time the market" is easy to articulate but significantly more challenging to adhere to. Anyone can adopt this strategy, as it is largely detached from an individual's cognitive abilities, judgment, or financial acumen. The difficulty arises from our innate susceptibility to emotional influences, which can skew our decision-making processes.

For instance, the understandable allure of a peer's windfall from the stock market can lead us down a slippery slope of poor choices. Our selective memory can also be deceptive; market watchers often lament, "I always knew that stock would rise! If only I had acted on that instinct!" Such hindsight can cloud our recollections of past hesitation, engendering a distorted perception of events. This backward-looking perspective cultivates a reliance on intuition, prompting many to believe they can outsmart the competition. Unfortunately, this mindset may spiral into a dead-end for the majority of investors.

Emotional pitfalls lead to increased risk exposure and higher transaction costs, lending to a cyclical pattern of pessimism in downturns and unwarranted optimism in upswings. The resulting frustration is palpable when poor decision-making culminates in subpar returns; had we merely adopted a hold strategy, our outcomes would likely have been vastly improved.

Guide to successful investing

To genuinely capitalize on the stock market, one requires a disciplined investment plan—one that remains steadfast over the long term. Here, I summarize some fundamental investing principles derived from the extensive research covered in Siegel's work. These principles can aid investors, both novices and seasoned, in achieving their financial aspirations.

First and foremost, data over the past two centuries shows that real stock returns, adjusted for inflation, have averaged about 6% to 7% annually, with average price-to-earnings ratios sitting around 15 times earnings. Nevertheless, projections indicate that future real returns may be lower, possibly around 5%. This is largely due to changes in investor behaviors and trading costs that make high-quality diversified portfolios more accessible. As we transition from the 19th century into the present, a historical average P/E ratio of 15 is likely to elevate to approximately 20.

Secondly, stock investments represent ownership of tangible assets and serve as a formidable hedge against inflation over the long haul. In the post-World War II era, the US has experienced relatively benign inflation levels without substantially damaging stock market returns. However, in the short term, tightening monetary policies aimed at controlling inflation can suppress stock performance.

Thirdly, the risk associated with equities diminishes over time, while that of bonds tends to escalate. This heralds a clarion call for long-term investors to allocate a larger portion of their portfolios towards equities as compared to their short-term counterparts. The performance of stocks typically displays a mean-reversion tendency, evidenced by market shocks that can shift stock prices dramatically while stabilizing long-term yields. In light of this, a greater allocation towards equities and a lower reliance on bonds can be beneficial for long-term portfolios.

Fourth on the list, it is prudent to invest a significant portion of your equity assets in low-cost, globally diversified index funds. Over the past five decades, broad-based index funds have consistently outperformed the vast majority of managed funds. By aligning oneself with an index fund, investors will almost assuredly achieve returns commensurate with market averages, thereby maximizing potential returns in the long run.

Fifthly, diversifying into international markets is critical. At least one-third of equity investments should be allocated toward global markets, including companies headquartered outside the US. Rapidly growing economies may often lead to inflated stock valuations, thereby offering lackluster returns to investors.

As of now, US equities represent roughly half of the global stock market capitalization. While the US market has outpaced others over the last decade, 2022 saw US stocks boasting some of the highest valuations in the world. The historical tendency indicates that lower valuations have a better chance of delivering superior returns, urging investors to consider their allocation strategies.

Lastly, value stocks, characterized by trading at lower valuations based on fundamentals such as earnings and dividends, have historically yielded better returns with lower risks than growth stocks. As investment strategies evolve, investors can either buy into value indices or newer funds focused on fundamental strengths to recalibrate their portfolios favorably.

A recent period from 2006 to 2021 marks the lowest performance of value stocks relative to growth stocks in the last century. Historically, growth stocks encounter periodic cycles of overvaluation approximately every 25 years, as evidenced during market phenomena such as the "Nifty Fifty" of the 1970s and the tech bubble of 2000. Although the recent rise of technology giants may be justified, the value investment strategy—a principle rooted in the concept that prolonged underperformance can lead to future outperformance—remains relevant as sound investment practice.

Ultimately, implementing a stringent investment strategy is paramount to keeping your portfolio on course, especially during times of emotional distress. If market fluctuations instill anxiety, revisiting foundational readings or historical performance data can help restore clarity and reaffirm long-term investment commitments.

Investor sentiment can play a pivotal role in stock price evaluations, leading to overvaluation or undervaluation based on collective emotional responses. The difficulty in resisting impulses to participate in buying when optimism is rampant or selling in fearful conditions is a prevalent challenge. Many who succumb to active trading often discover that their returns lag significantly behind the market averages. By nurturing an understanding of the fundamental underpinnings of long-term stock returns, investors can cultivate the discipline to remain invested despite the stormy waters that accompany financial markets.