Key takeaways
People make two common financial mistakes: not investing or doing too much.
When it comes to investing, doing nothing is often the most intelligent thing to do. Research shows that buying and selling destroy wealth and that inactive accounts produced the best returns, on average.
Compounding capital growth takes time. Quality assets and time are the key ingredients for increasing equity.
Changing your investments or strategy just because you're impatient destroys wealth, so make changes only if the market hasn't delivered returns in the time frame that you expected.
In the long run, fundamentals will drive returns. If you invest based on sound fundamentals, and you use evidence and a rules-based approach, you should not change your investment unless there is overwhelming evidence that long-term fundamentals have changed.
I find it ironic that the two common financial mistakes that people make are
- not investing i.e., procrastination or
- doing too much i.e., turning over investments, changing their minds and so on.
But, sometimes reacting, changing, tinkering, selling, buying and so on can be equally as bad.
The truth is that investing requires a lot of patience.
The quote below from Warren Buffett’s business partner since 1975, Charlie Munger says it perfectly:
Look at those hedge funds – you think they can wait? They don’t know how to wait! I have sat for years at a time with $10 to $12 million in treasuries or municipals, just waiting, waiting…As Jesse Livermore said, ‘The big money is not in the buying and selling…but in the waiting.
When it comes to investing, doing nothing is often sometimes the most intelligent thing to do.
Research demonstrates that buying and selling destroy wealth
There’s a commonly cited story about global fund manager, Fidelity conducting research into which investment accounts performed the best.
It is said that it found that inactive accounts i.e., where the investor forgot that the account existed produced the best returns, on average.
A study that included 66,465 investors concluded that portfolio turnover (i.e. buying and selling stocks) is inversely related to returns.
That is, higher turnover leads to lower (about 5.5% per annum) returns, on average.
Whilst this study only considered stocks, the same would be true for every other asset class.
Three reasons why you need the discipline to be patient
If you have the discipline to be patient, you will enjoy much better investment returns for three reasons.
(1) Markets move in cycles
Most investment markets move in cycles.
That is, a period of above-average returns follows a period of below-average returns, as shown in this chart of historic property returns:
If you were unlucky and invested at the beginning of a flat growth period, it’s likely that you must hold an asset for a much longer period to generate a return close to the long-term average (i.e., 7-8% per annum.).
For example, generally, you must be prepared to hold a property for at least 10 years to enjoy the long-term average return (i.e., 7-8% per annum.).
However, if you invest at the beginning of a flat period, you’ll have to hold the property for 15 to 20 years.
Returns should be similar in both cases (i.e., 7-8% per annum).
The difference is the distribution of returns over time.
Investment-grade apartments are a good example of this.
(2) Returns compound
Compounding capital growth takes time.
As the chart below demonstrates, the projected growth (equity) in the first decade of ownership is $580k.
But in the third decade is projected to be $2.7 million!
That is the power of compounding returns.
The two key ingredients are (1) quality assets and (2) time. When it comes to the impact of time, there are no shortcuts.
(3) Minimise transactional costs
Changing your investments or strategy just because you’re impatient destroys wealth, due to transactional costs and taxes.
That is not to say that you should never make any changes.
Of course, if you have a dud investment or recognise that you have made a strategic mistake, you must fix it as soon as possible, almost irrespective of the cost.
But making a change simply because you’re impatient i.e., the market hasn’t delivered returns in the time frame that you expected despite the asset quality is acceptable, is a mistake that must be avoided.
In the long run, fundamentals will drive returns.
When it comes to investing, often, the best thing to do is nothing
Most investors are influenced, to some extent, by fears and uncertainty.
Humans are hardwired to predict and avoid risky situations.
Therefore, we are susceptible to being influenced by negative news.
Of course, that’s why media outlets thrive on negativity.
But what we must remind ourselves is that fundamentals never change.
And negative events come and go – but fundamentals are everlasting.
Take the pandemic as an excellent example.
It was a global phenomenon – as big as a negative event can get.
But it too will pass, and investment markets will get back to normal, as we have already started to see.
Therefore, if your original investment decision was based on sound fundamentals, using evidence and a rules-based approach, then you must not make changes to that investment unless there’s overwhelming evidence that long-term fundamentals have changed.
Heed Queen Elizabeth II’s advice
In the Netflix series The Crown, Queen Elizabeth II said “To do nothing is often the best course of action, but I know from personal experience how frustrating it can be.”
I know this is a historical drama series, and it's uncertain whether the Queen actually said this, but the statement really resonated with me.
That’s because it eloquently describes exactly what it’s like for successful investors.
You feel tempted to make changes when you shouldn’t.
Or delay investing simply because you’re unsure.
It’s like logic and emotion are having a tug-of-war inside your head.
In times of high uncertainty/volatility, buy but never sell
High levels of uncertainty, often created by negative news, tend to be a fantastic buying (investing) signal – take Covid and the GFC as an example.
In the short-run, markets completely ignore fundamentals.
If you have the discipline to drown out all the noise (sometimes it’s easier said than done) and focus solely on fundamentals, it can be an opportunity to make good investments.
Similarly, when the conventional wisdom is that there are no risks and there’s the only upside, often that could be the best time to sell (if you need to do so as part of your strategy).
The best thing is to do nothing
If you have invested in high-quality, fundamentally sound assets, the best thing is to drown out any negative noise and do nothing. In the long run, the investors with the most patience receive all the financial rewards.
ALSO READ: Good financial decisions are a compounding asset
