SAFT ON WEALTH: The wisdom of exercising patience
“Don’t just do something, stand there!” might just be the best least-followed advice in investing. If there is one statistic that is, if anything, more depressing than the last empty decade of equity returns, it is the fall and fall of average stock holding periods.
It is also true that the obsessions of the quarterly company earnings cycle can foster a short-term volatility-oriented style in investors who should be thinking in years not months. Much of what gets written about stocks by analysts and discussed on television turns out to be so much noise, background static, that is best tuned out.
While the average holding period of a NYSE-traded stock was 10 years in the late 1930s the trend since 1995 has been down and down, driven by ever more frenetic trading. By 2010 the length of time the average share is held is down to a mere six months, according to NYSE data, a real testament to the eternal triumph of hope over experience.
To be sure, the rise of high frequency trading has played a role in driving down average holding time, but others have become more active traders too. Estimates vary, but the average domestic equity actively-managed mutual fund in the U.S. has an annual turnover rate of between 89 and 130 percent.
This may be great for the brokerage and mutual fund industries, but for investors it is just about the opposite of what should be happening.
“Be patient and focus on the long term. Wait for the good cards. If you’ve waited and waited some more until finally a very cheap market appears, this will be your margin of safety,” famed value investor Jeremy Grantham of GMO wrote in a note to clients.
“Now all you have to do is withstand the pain as the very good investment becomes exceptional. Individual stocks usually recover, entire markets always do.“
The poker metaphor is apt. Like playable poker hands, great investment opportunities don’t come along that often, certainly far less often than we would like. The natural tendency, then, is to try and force things by assuming that our jobs as investors is to always be fully invested and to simply choose the best available option.
While cash in a portfolio is a wasting asset, losing purchasing power to inflation over time, it is also extremely handy when opportunities actually present themselves. The less clarity there is about the outlook, and right about now there is very little, the higher the option value of cash.
Low conviction, high activity
And yet so many investors carry on doing a lot of low conviction trading, as if they can somehow make up in volume the lack of excellence in their individual investment ideas.
That’s natural, as human beings tend to favor activity over observation, though that is a strategy that perhaps worked better for our ancestors seeking food sources on the primordial savanna then it does for an investor screening stocks.
This tendency is doubly true for professional money managers, who feel pressure to appear to be working hard and who may benefit from fee-generating activity. Grantham sees the freedom from this as a key advantage individuals have over professionals, though his own career demonstrates that you can be successful and patient.
It is also true that the obsessions of the quarterly company earnings cycle can foster a short-term volatility-oriented style in investors who should be thinking in years not months. Much of what gets written about stocks by analysts and discussed on television turns out to be so much noise, background static, that is best tuned out. This does not mean that earnings beats and misses are to be ignored, but that it is really easy to get mesmerized by the expectations machine that is financial markets and get sucked, emotionally, into trading too often.
The other key thing to remember is that patience is important as both a buyer and a holder of shares. It is important to wait for your margin of safety in valuation before buying, but as a holder it is also important not to sell too quickly when the market goes against you.
And of course, the one sure thing in all of investment is costs. When you make a trade the losses or gains you may get in the future are only a matter of speculation and conjecture, the execution cost of the trade is the only thing that is inevitable and easy to measure.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at email@example.com and find more columns at http://blogs.reuters.com/james-saft)