A person's real attitude toward investing only becomes obvious with time. One person initiates an investment approach and sticks to it for 20 years, while another switches after it doesn't "work" over three. The result is almost always good performance for the person who sticks to one approach, and terrible results for the person who changes course every three years.
In my opinion, the cause of this short-term-orientation is twofold.
First, human psychology really does a number on us. Our caveman brain evolved to handle different problems. You don't need more than three years of data to decide whether you should run from a hungry lion or a pack of wolves. But, hunter-gatherers and farmers need to think longer-range to survive. Unusually bad winters and poor rainy seasons don't happen every year, but when they do, you'd better have enough food and clothing stored, or you won't survive. On an evolutionary time-scale, this thinking is pretty new to us. As a result, we make lots of mistakes when our caveman emotions take over from our long-range, reasoning mind.
I'm as prone to this difficulty as everyone else, much to my distaste. My biggest investing mistakes are seldom a refusal to sell something bad, but impatiently selling something too soon. I, too, have suffered from short-term-orientation with investments that weren't "working," only to see them take off shortly after selling.
I sold Berkshire Hathaway in November 2009 (having held it for 3 1/2 years) shortly after Buffett bought the Burlington Northern Santa Fe railroad. Buffett was clearly signaling that his company would never grow like it had in the past. The stock then jumped 21% in four months. I was right about underlying growth, but wrong to have sold at a low price to fundamentals.
I sold UnitedHealth in November 2010 (3 1/2 year holding, also) after company management had repeatedly described how new health care legislation could rapidly change their business model. The stock proceeded to climb 44% in the eight months after I sold. Once again, I was right on the fundamentals of the business, but wrong on the decision to sell when price to fundamentals were still too low.
My purpose in giving these examples is not to highlight what a moron I am (I've actually gotten many more right than wrong--no really!), but to illustrate that even someone aware of the psychological traps of investing can still fall into them. The solution is better process, which is fertilized with a thorough, rational analysis of past mistakes.
The second reason I think short-term-orientation sets in has to do with the fundamental nature of investing and business cycles, which are wildly variable in amplitude and duration. Just as you can't decide the quality of farmland without considering weather cycles, so you can't decide what's going on with an investment without considering investing and business cycles--and that makes analyses more difficult.
Investing cycles are caused by the boom and bust mentality of investors. One year investors eagerly pay 20x earnings for an investment, and another year they won't pay 5x. This boom-bust cycle is caused by the psychology of investors as a herd. They go from euphoria to terror and back again over time, and no one can predict how long the cycle takes or when it will reach its zenith or nadir.
Business cycles, which are less psychological than investing cycles, are caused by a variety of things (including government policy, fads and fashions, competitive dynamics, just to name a few). Like investing cycles, business cycles follow unpredictable paths that can distort the information investors need to make good decisions. A rational analysis of long-term sales and margins over the full cycle is required, as is an in-depth analysis of industry and company dynamics. Is a downward cycle permanent, or temporary? Has a paradigm shift occurred that makes the business model defunct? Only time will tell.
Investors generally have a hard time handling investing and business cycles. Its easy to panic and "throw in the towel" when the future is unknown, but it rarely generates good investment returns. People would love to know if their investment approach is working by seeing results right away, but the world is too complicated to say one, three or even five years of data are enough. It depends, and each cycle is different than the last. It's more constructive to look at long data samples, but few have the patience or desire for such work.
Given that, what's the solution?
First, you'll only stick to an approach over the long run if you really--deep down--know it works. If you've looked at the long term data, you'll know that value investing crushes growth investing over the long term. If you spend enough time picking the right approach (or the right manager), it's possible to ride through periods of under-performance that can last as long as a decade. If not, you'll panic and abandon ship at just the wrong time.
Second, you'll have to do battle with your psychology. You will feel emotions when your investments tank. You will want to throw in the towel when something isn't working for several years. Be ready to fight your emotions with reason, data, analysis, or whatever else helps you. I've found temporary distraction works, as does exercise, deep breathing, meditation, reading. Do what you must to hold emotion at bay and focus on the facts. Only then will you stick to your approach.
Our caveman brain and variable cycles make sticking to an investment approach very difficult, but not impossible. The rewards, however, are truly extraordinary and well worth the time, effort and intermittent anxiety.
Find the right approach, and stick to it!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
No comments:
Post a Comment