Wednesday, 4 February 2009

Psychology of Stock Market Investing: Patience

"We have met the enemy and he is us."
Walt Kelly in the Pogo comic strip

As has oft been noted, psychology is the greatest barrier to successful investing as we do things that cause us to under-perform - and by a lot, not just a bit.

The research firm Dalbar found in the study Market-Chasing Mutual Fund Investors Earn Less Than Inflation that US investors in equity mutual funds managed a measly 2.57% annual compound return compared to inflation of 3.14% and the 12.22% that the S & P 500 index earned annually for the 19 years from 1984 to 2003. The reason for the poor result - attempts to chase market performance by hopping from one hot fund manager to another but always one step behind. In other words, investors lacked patience. The problem doesn't just apply to mutual funds but to stocks as well, as investors buy hot stocks after a rise or a friend has whispered a hot tip or a TV show analyst mentions that he likes the company, only to be disappointed and sell at a subsequent decline.

Eric Sprott, one of the most successful Canadian investors and money managers ever with annualized returns of almost 25% since 1982, has found that even with his remarkable record, investors in his fund have become impatient and withdrawn money in the rare down years of his fund (cited in Bob Thompson's new book Stock Market Superstars). He says, "... a short time period is not a very good measuring stick. Really, the longer term is a better measuring stick." Another Superstar, Wayne Deans, says "I think the single biggest weakness with most investors is that their time horizon is way too short." What Sprott and Deans mean by longer term is years. They talk about the patience to wait perhaps several years after they have made an investment in a stock they feel is under-valued in order for the market to catch up and for the price to go up. They also mention how they have had to learn to not sell too soon after the stock price of such a company has at last begun to rise.

It should of course be a moot point that if you need to spend the invested money sooner and cannot wait a few years, then the stock market is not the place to invest.

Antidotes to impatience:
  • look at statements less often, perhaps only once a year if your time horizon is many years, or if you are invested in a fund with a professional manager, be it passive indexing or actively-managed; after all, that's why you pay them - to manage your investment
  • graph prices or values with a five-year or greater time axis to keep rises and falls in proper perspective, especially important nowadays after major market declines
  • write down the reasons for buying then when you feel the urge to act, review them to see if they still hold before doing anything; the initial recording will force you be a more systematic and rational at the buy stage and the review at the sell, instead of giving in to impulse. Impatient investors forget that the outstanding investors only act quickly and decisively after doing considerable research to know what they are buying, thus developing an idea of buy and sell value.
Behaving patiently is not easy, as even the Superstars attest. Bob Thompson summarizes - "Many of the managers interviewed, from value to to growth to hedge, said that they wish they were more patient, and it was something they were always working on."