Among the cute cat videos and other random fluff on YouTube, there’s actually some great content for investors. One of the best examples, in my view, is a presentation from top UK fund manager Terry Smith. Indeed, I think this talk contains one of the most important bits of advice for anyone wanting to make a million from the stock market.
It’s not (all) about the price
Having summarised the approach of his quality-focused, flagship Fundsmith Equity Fund, Smith explains why the price of a stock is not the most important consideration in his investment approach. To do this, he uses a hypothetical example (49 minutes 57 seconds in) of someone investing in the US stock market at its low, back in 1917, and selling at the height of the dotcom boom in 1999.
Over this 82-year period, this investment generated a very-decent annualised return of 11.6%. At first glance, this appears to show that market timing is the route to riches.
Having performed the calculations for his audience, however, Terry Smith shows why this isn’t the case.
Timing isn’t everything
Despite the brilliance (or luck) of this investors’ timing, it doesn’t actually contribute all that much to their eventual returns.
To be more specific, only 20% of this outcome was due to when he/she bought and sold their investment. By contrast, 80% of gains were down to what the companies did over this time period.
To further cement his point, Terry Smith then uses the example of Unilever. Between 1995 and 2016, the FTSE 100 company generated an annualised return of 10.9%.
While again providing a solid return for holders, only a very small part of this result is due to the rise in valuation. The vast majority of the investment’s success (90%) is due to Unilever reinvesting and compounding its earnings over time. In other words, timing matters even less with a quality business.
I don’t know about you but I find Smith’s example both informative and comforting.
First, it suggests that investors should direct their energies to finding the best companies they can invest in. For Smith, this means focusing on resilient, non-cyclical businesses with great brands and predictable earnings.
Second, it neatly summarises why we should avoid the hand-wringing exercise that is trying to time the market. If history is anything to go by, it contributes little to returns. This is why we shouldn’t fear another market crash if we plan to invest for many years. To paraphrase Terry Smith, just ‘buy right and wait’.
One last thing…
If you agree with Smith’s thinking (and his performance over the years suggests you really should), it also makes sense to focus more on retaining the money your investments generate. For anyone looking to become a millionaire from the stock market, this means keeping your holdings within a Stocks and Shares ISA.
The ISA wrapper allows you to shield any profits you make from the taxman. This means more of your money is allowed to compound over time. And when the time comes to switch from growth to income-generating stocks (perhaps when you retire), an ISA will also save you from paying tax on the dividends you receive.
We may not have 82 years to invest like the person in Terry Smith’s example, but with the correct system (and minimal meddling), the end result could still be very impressive.
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Paul Summers owns shares in Fundsmith Equity Fund. The Motley Fool UK has recommended Unilever. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.