In this age of low commission fees, it is easy to find yourself trading too often, especially when you are a new investor. However, countless studies and no less than an investing master, Warren Buffett, point out that market timing and frequent trading are easy ways for investors to underperform the market over the long term.
Here are some quotes from the Oracle of Omaha on one of the most important aspects of successful investing.
“When we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint.”
— 1988 letter to shareholders
“Lethargy bordering on sloth remains the cornerstone of our investment style: This year we neither bought nor sold a share of five of our six major holdings.”
— 1990 letter to shareholders
“Inactivity strikes us as intelligent behavior. Neither we nor most business managers would dream of feverishly trading highly-profitable subsidiaries because a small move in the Federal Reserve’s discount rate was predicted or because some Wall Street pundit had reversed his views on the market.”
— 1996 letter to shareholders
“Experts” do no better
But you could argue that most investors are just regular folks who do not have the time and expertise to follow the markets daily and scour through financial filings. Surely professional money managers, those who have devoted their lives to beating the market, can do better — right? Actually, no. It turns out most money managers end up underperforming a simple buy-and-hold strategy.
Since 2001, S&P Dow Jones Indices has released its annual SPIVA U.S. Scorecard report, which examines the performance of fund managers relative to their most closely linked benchmark index. Over one year, 68.83% of all domestic funds underperformed their respective benchmark index. But it gets worse when the performance of fund managers is examined over the long-term. Over the past 15 years, a whopping 88.97% of domestic funds have underperformed their respective benchmarks.
Most investors are too focused on the short term
What explains these disturbing findings? Partly, it’s basic human psychology, which affects even professional money managers.
Often fund managers are doing too much to beat their respective index. More specially, they are focused on the short term when they should have their eyes on the horizon. For context, Michael Laske, a research manager at investment company Morningstar, found that the average turnover ratio for domestic stock funds through February 28, 2019, was 63%. The “turnover ratio” represents the portfolio churn rate or the percentage of holdings that have been changed over a defined period. In this instance, Laske found that pretty much five out of every eight stocks in a domestic fund were being changed out every year. That suggests very short-term thinking on the part of money managers.
As individual investors, we too can be easily caught up emotionally in our investing. For example, when markets are soaring, greed and a herd mentality tempt us to jump on the bandwagon, perhaps by investing in wildly overvalued shares of much-hyped growth stocks. However, since we react twice as strongly to losses as gains, we are again overcome by an almost unstoppable need to sell when markets tank.
The Coffee Can Portfolio: A lesson in holding on
One of our favourite investing articles on the power of long-term investing is The Coffee Can Portfolio, written by investment manager Robert G. Kirby in the 1980s.
In the article, Kirby shared a personal experience he had with a female client of his in the 1950s. He had been working with this client for 10 years – during which he managed her investment portfolio, jumping in and out of stocks and lightening positions frequently – when her husband passed away suddenly. The client wanted Kirby to handle the stocks she had inherited from her deceased husband. Here is what happened next, according to Kirby:
“When we received the list of assets, I was amused to find that he had secretly been piggy-backing our recommendations for his wife’s portfolio. Then, when I looked at the total value of the estate, I was also shocked. The husband had applied a small twist of his own to our advice: He paid no attention whatsoever to the sale recommendations. He simply put about $5,000 in every purchase recommendation. Then he would toss the certificate in his safe-deposit box and forget it.
Needless to say, he had an odd-looking portfolio. He owned several small positions with values of less than $2,000. He had several large holdings with values above $100,000. There was one jumbo holding worth over $800,000 that exceeded the total value of his wife’s portfolio and came from a small commitment in a company called Haloid; this later turned out to be a zillion shares of Xerox.”
The revelation that buying and then patiently holding shares of great companies for the long-term had generated vastly superior returns as compared to more active buying-and-selling helped Kirby to form the basis for his Coffee Can Portfolio idea. He explained:
“The Coffee Can portfolio concept harkens back to the Old West, when people put their valuable possessions in a coffee can and kept it under the mattress. That coffee can involve no transaction costs, administrative costs, or any other costs. The success of the program depended entirely on the wisdom and foresight used to select the objects to be placed in the coffee can to begin with.”
Commit to being a long-term investor
We are sure you have seen some big moves in the overall market in your time as an investor. The urge to grab a quick gain or to quickly let go of a “loser” can be strong. However, the obsession with checking stock prices, the frenetic buying and selling, the hand-wringing over the economy and bad news could be the very hurdles to successful investing. Maybe it is time for you to extend your investment time horizon and embrace lethargy and sloth. The idea is simple: you find the best stocks you can and let them sit for as long as possible.