Consider investment horizons and the benefits of long-term compounding.
Could you hold your current investments for a quarter-century or more without making a single trade? This autumn, college students at both the University of Virginia and Delaware State are participants in an extreme version of “set it and forget it”. The students will select investments they can’t trade until 2048. Each year, new participants will buy another batch of stocks that will also be frozen for 25 years. (The long-term experiment is being funded up to US$750,000 by the chief executive Markel Corp., an insurance company.) At the end of the first quarter-century, half the accumulated gains will go to student scholarships and the remainder will be reinvested by new members from the Class of 2048.
The experiment is based on the classic “Coffee Can Portfolio” which originated in the Old West when people stored their valuables in coffee tins which they kept under the mattress for many decades. Studies show that a key reason that investors tend to underperform stock market indices is due to over-trading. In fact, the most frequent traders underperform by more than 7 percentage points annually which dramatically reduces long-term returns.
There are a variety of reasons why investors tend to overtrade. Some of these are gender-based— young men are more active traders and take more financial risks than women and older men—while others may be related to the 24-hour business news cycle which reinforces compulsive financial activity.
The allure of the Coffee Can portfolio is it counteracts these negative tendencies because it forces us to consider investments, not as stock tickers or memes, but as actual businesses. By being unable to trade selections for a quarter-century, it forces an investor to think long and hard about the merits of the specific company. Will it be able to grow and compound value for 25 years or more?
No investor has a crystal ball that can know with certainty which companies will succeed, fail, or merely tread water over the long-term. An advantage of the Coffee Can portfolio is we don’t have to know the answers to be successful. In his recent shareholder’s letter, Warren Buffett, co-chairman of Berkshire Hathaway and one of the world’s most successful long-term investors, wrote: “The weeds wither away in significance as the flowers bloom”. In other words, time will make the selection for you: the better investments will hold more weight in your portfolio and the weaker investments will shrink in size to insignificance. Therefore, it’s not surprising to learn that Buffett’s favourite holding period is “forever” for such holdings as Coca-Cola, Apple, American Express and other long-term compounders of value.
Despite its merits, it’s important to remember the Coffee Can portfolio is not passive. Investors can’t just “check out”. We must always keep an eye out to make additions and subtractions as needed. But it is a good reminder of the long-term benefits of resisting the urge to constantly tinker and simply to let our (financial) garden grow.