The traits needed for success are also those that land you in trouble
Optimism and boundless confidence can take an investor to the top but also blind him to risk
Reversion to the mean is one of the most common stories in history, says Morgan Housel at Collaborative Fund. It’s the main character in economies, markets, countries, companies, careers — everything, he adds.
That applies to investing, where it now seems harder to sustain success over an extended period of time. Why is stock market success so fleeting?
Part of the answer lies in recent developments: new technology, more information and more players have undoubtedly made it more difficult to stay on top of the game.
But there is another set of factors that has more to do with our make-up, and that has always made it difficult for investors to achieve long-term success in the stock market.
The traits needed for success are also the traits that get people into trouble. As Housel puts it: “What kind of person makes their way to the top? Someone who is determined, optimistic, doesn’t take ‘no’ for an answer and is relentlessly confident in their own abilities.
“What kind of person is likely to go overboard, bite off more than they can chew and discount risks that are blindingly obvious to others? Someone who is determined, optimistic, doesn’t take ‘no’ for an answer, and is relentlessly confident in their own abilities.”
Long-term success requires two tasks: getting something and keeping it. These things often require contradictory skills.
“Sometimes a person masters both skills,” says Housel. “Warren Buffett is a good example. But it’s rare. Far more common is big success occurring because a person had a set of traits that also come at the direct cost of keeping their success.”
Buffett says: “Our inability to deal with volatility, especially the big market corrections, is another impediment to longterm success. Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.”
Unfortunately most of us can’t. Which is why, as Michael Batnick points out at The Irrelevant Investor, despite the Dow opening the 20th century trading at 68 and closing at 11,497 —a 16,875% increase — nobody got these returns, and those who achieved even a fraction of them had to endure unthinkable pain along the way. Stock prices were lower in 1932 than they were in 1900. In 1974, stocks were trading at the same levels as they were the winter of 1958. The Dow was lower in 2009 than it was in October 1996.
To make matters worse, the doomsayers, though seldom right, are ever present. The bears make poignant arguments that are almost tailor-made to touch something deep inside us. The bearish arguments consolidate and retain bad news more firmly and for a longer time than good news. To quote Janice Dorn: “The rah-rah cheerleaders are often seen as buffoons, whereas the permabears are the scholars and masters of Latin.”
This brings us to the next stumbling block to long-term success: poor advice. Part of the problem is that there are so many mediocre talents working in the field that can pass themselves off as exceptional because they believe it to be true. Guru investors can have the effect of artificially running prices up or down to the indirect benefit of the few.
“My general rule of thumb is to ignore making decisions based on investing sound bites from legendary investors,” says Ben Carlson at A Wealth of Common Sense.
“There’s a good chance they have way more money than you, so the circumstances are completely different. Billionaires are playing a different ballgame than you and me.
“Then there’s the fact that you have no idea what their time horizon, risk tolerance or overall strategy are in regards to their quip about the markets.
“And finally, most really great investors are also really great marketers. So there’s no way of telling whether they’re really serious, just trying to earn some publicity or raise more money. Investing based on sound bites is tempting, but it’s more trouble than it’s worth.”
That’s not to say these unusually successful people don’t have a great deal to offer. The problem comes when you try to imitate them rather than find your own edge.
As Marcus Padley says: “The closest anyone who relies on a few Warren Buffett quotes is ever likely to come to the Warren Buffett way is wearing a cardigan and living in the same house for the rest of their life.”
The siren call of Wall Street is another serious hurdle to longterm success. Campbell Harvey looks at Wall Street and sees a lot of ideas that are easy to sell but hard to trust. The Duke University finance professor has made a career out of challenging research backing the products firms pitch to investors. A lot of it, he says, just isn’t sound.
His studies have shown that more than half of all research pumped out by both academics and analysts is “likely false”.
Then there’s the fact that what’s worked in the past often stops working. While it’s intuitive to look at what’s worked in the past, there’s a danger in relying on outdated trends.
“If we treated dividends like the polio vaccine,” says the Motley Fool, “we might think we can look at the past, figure out what’s worked, and apply it to today’s market. But dividends change like the flu virus.”
Facebook and Google pay no dividends but are some of the healthiest businesses in the world. High dividends are now the refuge of utility companies and struggling oil pipelines — the opposite of how markets operated for most of history. And yet Apple and Microsoft are high dividend payers too. So dividend performance may tell us far less about future prospects than the long guide of history suggests.
Finally, there’s the role luck played in prior successes.
“There is a test to determine if there is any skill in an activity,” says Michael Mauboussin.
“If you can lose on purpose, then there is some sort of skill. Investing is interesting because it is difficult to do a lot better than the benchmark. But it is also hard to do a lot worse. What that tells you is that investing is pretty far over to the luck side of the continuum.”
Luck is not sustainable.
WHILE IT’S INTUITIVE TO LOOK AT WHAT’S WORKED IN THE PAST, THERE’S A DANGER IN RELYING ON OUTDATED TRENDS
THE RAH-RAH CHEERLEADERS ARE OFTEN SEEN AS BUFFOONS, WHEREAS THE PERMABEARS ARE THE SCHOLARS