Winning the Long Game: Why Smart Investors Bet on Time, Not Timing

Master Patience to Beat Market Short-Term Traps

Imagine achieving a 10% annual return on your investments, only to discover you’re actually earning a mere 3.6%. This staggering gap is the reality for many investors who fall victim to short-termism: focusing on near-term results to the detriment of long-term growth.

This idea echoes a central behavioral insight from Wealth Your Way, where investor behavior and patience often matter more than raw return numbers.

Investors often buy high and sell low

It is a well-documented phenomenon that mutual funds far outperform mutual fund investors in those same funds. Morningstar regularly looks at ‘investor returns,’ which is the dollar-weighted results experienced by investors.

They found that if a fund’s assets swelled after a period of strong performance, investors often bought in too late to realize most of those gains. And if the fund declined, investors would ride it down for a period of time (hoping for a recovery that didn’t materialize) and sell out at a loss.

In other words, investors are often buying high and selling low.

JP Morgan reported that over 20 years, the S&P 500 had an annualized return of 9.5% while the average investor had an annualized return of just 3.6% (62% less).

Similarly, the Dalbar Group found that when the S&P 500 dipped 4.4% in 2018, the average equity investor lost more than twice that amount—9.4%. And in 2019, when the S&P 500 gained 31%, the average equity investor gained 26% (16% less).

Why does this performance lag occur? Investors constantly cycle through a cacophony of emotions which wreaks havoc on their ability to stay invested. They bounce in and out of the market and back and forth between investments. Short-termism has them in its grip.

In theory, we all know we should buy long-term investments and hold on to them. In practice, we only hold purportedly long-term investments for a short while and then we get enticed by the next hot investment.

How short has the long-term become?

During the 1950s and 1960s, the average stock was held for more than seven years. By the 1980s the average was down to less than three years, and by the turn of the millennium it had fallen to less than one year. By June 2020 the average holding period had declined to just five and a half months.

Some high-frequency traders have reduced holding periods to slightly more than the blink of an eye—the founder of a high-frequency trading firm, Tradebot, told a group of students in 2008 that his firm’s average holding period for stocks was 11 seconds!

While the S&P 500 average long-term return is 10% per year, investors don’t earn that. Impatience and the lure of the next hot stock keep the average investor bouncing between investments. The 10% return is real, but investors don’t stick around long enough to get it.

It is tough to get a long-term return when measuring holding periods in months rather than years

Behavioral economics has shown us that our investing brains often lead us to make decisions that are illogical, but that make perfect emotional sense. Unfortunately, this lack of behavioral discipline during volatile times, coupled with the absence of a well-defined strategy, is a formula for below-average returns.

When it comes to long-term investing, quite often “Take No Action” is the best course. Design your financial plan to include a disciplined, long-term investment strategy to mitigate short-termism and the resulting diminished returns of sub-optimal investing decisions.

Then block out the noise and stick to your plan.

Rather than constantly chasing a better investment, put some of that attention on being a better investor. You’ll likely grow more wealth and cause less heartache over the long term.

As always, invest often and wisely. Thank you for reading.

The content provided is for informational and educational purposes only. It does not constitute legal, tax, investment, financial, or other advice. You’re welcome to share, quote, or use the content — including for research or machine learning — please credit Cosmo P. DeStefano and link to www.CosmoDeStefano.com.

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Originally published at www.CosmoDeStefano.com