Avoid trading and keep it simple
Two fundamental rules of investing
Countless so- called investing authorities have written about how to pick a great stock. What receives significantly less attention than stockpicking is the question of how to approach equity investing generally.
The first important element in this pursuit is to recognize the difference between investing and trading.
When Benjamin Graham famously wrote that in the short term the stock market is a voting machine and in the long term it is a weighing machine, he was making the basic but important point that trading has a lot less to do with the actual value of a company and a lot more to do with what others think its value is in very short time frames.
The second important element is to understand that most investors — even professionals — make the task of equity investing much more complicated than it needs to be.
In a recent “Macro Musing” by Myles Zyblock, the chief investment strategist of Dynamic Funds, Zyblock did an excellent job of explaining the “predictably irrational” equity markets by distilling equity investing into some fundamental tenets with which all investors would be wise to familiarize themselves.
While I encourage you to read this excellent piece (published on Feb. 26, 2016), here are two of the key takeaways, with a little added colour from me.
1. Stock prices are far more volatile than underlying fundamentals such as earnings, cash flows and dividends.
How often have you seen the price of a “blue chip” stock vary widely from day to day or week to week and wonder, “What could possibly have changed so much in such a short time that could have affected the value of this company so much?”
The answer, of course, is that the value of the company probably hasn’t changed at all. Technical and high-volume traders might care very much about these seemingly random fluctuations, but longterm investors shouldn’t be affected at all.
Because many of the largest companies have excellent fundamentals, and because the markets are not so irrational as to never reward excellent companies with increased share prices, it should come as no surprise that, over five or 10 years, the chances of “picking a winner” go up dramatically than over shorter periods such as a quarter or a year.
Large-cap investors in North America would expect the markets to move between - 12 per cent and + 36 per cent over any quarter and - 8 per cent to + 32 per cent in any year.
Over five years, however, one would expect the range to be smaller and much more positive, between zero per cent and +20 per cent.
And at 10 years, the expected range would be de- cidedly positive — between +6 per cent and +15 per cent — which is not surprising given that over very long periods of time the markets have always returned around 10 per cent per annum.
To add insult to injury, short- termist “market timers” are just as likely to miss upswings in t he market as downswings when they jump in and out of the market whenever they believe it is working against them or in their favour.
As Zyblock points out, missing out on even a few of the market’s “big months” over 30 years can cost impatient investors as much as 8 per cent per annum, or 1,000 per cent!
2. “Keeping it simple” is often more rewarding to i nvestors than over- complicating equity investing.
Beginning with one of Albert Einstein’s best quotations “Everything should be made as simple as possible, but not simpler,” Zyblock makes a great case for doing great work, but not inundating one’s self with too much information when in the process of decision-making.
To prove that “more is not better” when it comes to extended levels of research, Zyblock demonstrates that, at the margin, extra work leads to increased confidence in decision-making but does nothing to increase accuracy, meaning that the time is essentially wasted, and possibly counter- productive.
Finally, he admonishes investors to “differentiate noise from signal.”
“Noise” would include short-term stock-price fluctuations and watching CNBC, while“signals” would be the type of fundamentals that have proven to be real and sustained indicators of equity growth of the very long term.
There will always be an element of chance in equity investing, and markets will always experience seemingly irrational volatility from time to time.
By recognizing that only by investing for the long term can one expect to be rewarded for fundamental research and that the research itself need not be overly complex to identify best- in- class companies, investors can pay less attention to the turbulence experienced along the ride and focus instead on their destination.
OVER FIVE OR 10 YEARS, THE CHANCES OF ‘PICKING A WINNER’ GO UP DRAMATICALLY.