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The most inevitable headline of all time

After the US Dow Jones average hit a new record high this week, more than doubling its 2009 lows, the Wall Street Journal published one of the most inevitable headlines of all time.

“Market Rewarded Those Who Stuck It Out,” it read.

You don’t say.

The only thing worse than suffering through a period like the last five years is suffering through and not learning anything from it. To me, there are three imperative investment lessons from the last five years. That “markets reward those who stick it out” is one of them.

For those who stuck it out for the last five years, the 2008 crash — literally one of the sharpest wealth destroyers in history — is now a set of painful memories at worst, and a once-in-a-lifetime opportunity at best.

Back to the future

While the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) is still off its 2007 record high, the index doesn’t tell the whole story. Including dividends, according to S&P Capital IQ, the index is only 4% off the November 2007 high. If you bought steadily over the last five years, your portfolio is likely larger than it was then. Only if you sold near the bottom and hid somewhere else would an index-tracking investor have lost significant money.

History is clear on this: Hold stocks for a long time, and your odds of making money are very high. In the US, where historical records are more readily available, since 1871, there have only been four periods when an investor purchasing stocks didn’t make money in real (inflation-adjusted) terms over a 10-year period: 1908, 1929, the late 1960s, and the late 1990s.

If you purchased stocks once a month, every month, since 1871, 87.8% of your purchases would be profitable 10 years out, even adjusted for inflation. The four brief periods that left you in the red after a decade were invariably followed by above-average returns. That period includes the aftermath of a US civil war, two world wars, a flu pandemic, terrorist attacks, droughts, presidential assassinations, depressions, recessions, crippling debts, bank runs, high inflation, deflation, oil embargoes and a dozen bubbles. Through it all, the market rewarded those who stuck it out. It is the same story time and time again. It was no different this time around, and it will likely be no different next time around.

Don’t time the market

What else did we learn of the last five years? One of my favourite quotes from investor Jeff Gundlach is, “In risk assets, you make 80% of your money 20% of the time.”

During the 21,000 or so trading days between 1928 and today, the Dow Jones went from 240 to 14,000, or an average annual return of 5% (not including dividends). If you missed just 20 of the best days during that period, annual returns fall to 2.6% — which is to say, half of the compounded gains took place on 0.09% of days. That’s the numerical version of Gundlach’s wisdom.

Sure, if you missed the 20 worst trading days, you would have done much better. But most of the 20 best trading days and the 20 worst trading days happen during the same periods, often during the same months. So what happens is that those who try to avoid the market’s big drops tend to miss the market’s even bigger gains.

Those who sold when the Dow was at 8,000 may have thought they were smart when it continued to fall to 6,000. But when, before they knew it, it was back above 10,000, 12,000, 13,000, 14,000 … and their attempt to time the market ended up costing them serious money.

If you want to consistently enjoy the market’s big gains, you have to put up with its declines from time to time. Trying to avoid that reality is one of the surest ways to earn poor returns. This, too, is the same story over and over again.

Know your timeframe

One lesson from the past five years is that the single most important question an investor can ever ask is, “How long am I investing for?”

If you’re a day trader, a down day is a loss. If you’re five years from retirement, a down year can be scary. If you’re in your 20s and saving for retirement, a down decade means little. The same outcome during a given period of time can mean very different things for different people.

If you know you’re investing for the long haul, these ups and downs — even a severe crash like 2008 — take on a whole new meaning. I think a lot of why so many investors cashed out and hid on the sidelines over the last five years is because they never even asked themselves how long they were investing for.

A young worker with three decades before retirement saw markets falling, and his first instinct was, “Get out, now!” when it realistically should have been, “Look, never before in history has an investor lost money in stocks on a 30-year basis. And stocks are cheap right now. Even if they go down much further, it doesn’t make sense to sell.” On the other side, near-retirees found themselves caught off-guard when money they needed now suddenly lost half its value.

Foolish takeaway

So asking yourself how long you have to invest goes both ways. What’s important is that there is never a blanket definition of whether or not you should buy stocks right now. Who you are and how long you have to invest can create two different rational answers at the same time.

Someday, this will all happen again. More recessions, more crashes. And when it’s all over, the same headline — “Stocks reward those who stuck it out” — will be published yet again.

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More reading

The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool contributor Morgan Housel owns shares in Berkshire Hathaway.

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