7 Traits for Investing Greatness:
#1 Long-Term Perspective
Years of experience have taught me that becoming a successful Active investor is extremely difficult, requires a very specific set of characteristics, and that many investors attempting to actively manage their portfolios today lack the emotional and personality traits necessary for success.
Investors with Passive portfolios — presuming they are adequately and broadly diversified — face only one real point of failure: reacting emotionally to a market selloff and selling their holdings, often near a market bottom.
But investors who use actively-managed strategies are confronted with 2 points of failure:
- Reacting emotionally to a market selloff and liquidating their holdings.1
- Selling out of an Active strategy because it is doing worse than its benchmark.2
The second point of failure occurs even if the investor has earned positive returns in the Active strategy — let’s say a gain of 10% per year over the last 3 years versus a benchmark return of 12%. While all investors face the same point of failure when selling during market swoons, only Active investors face the second pitfall. What’s more, research has shown that managers who are fired due to a 3-year underperformance typically go on to outperform the manager with which the investor replaces them.3
Of course, this second point of failure can destroy long-term results even if the general market has been performing well. Sadly, I see this type of behavior often, leading me to conclude that, for many investors, Active management will never work precisely because they lack the emotional and philological traits required to succeed.
In total, there are 7 key traits that I believe are necessary to become a successful long-term Active investor. Let’s look at the first one here, and the other 6 in future posts:
#1 — Long- or Short-Term?
Successful Active Investors have a Long-Term Perspective on their Investments.
“Having, and sticking to, a true long-term perspective is the closest you can come to possessing an investing super power.”
— @CliffordAsness (1/25/17 9:32 p.m.)4
Mr. Asness is 100% correct but, sadly, most investors lack this ability. Evolution has programmed us to pay far more attention to what is happening now than to what might happen 10 or 20 years into the future. For our ancient ancestors, that made a great deal of sense. Those who reacted quickly to a rustling sound in a nearby bush — presuming it was a predator who could kill them — ran away and survived, whereas those who didn’t were often killed. Guess whose genes got passed down to us? Of course, it was those that ran away from the rustling bush, even if there was no fatal threat.
Our culture has evolved much more rapidly than our brains, which doesn’t help us keep a long-term perspective on our investments. When you time-weight short-term information for investment decisions, you create a reactionary model, not an anticipatory one.
Many behaviors that hobble making good investment choices seem to be encoded into our genes. In their 2012 paper “Why do Individuals Exhibit Investment Biases?”, Researchers Henrik Cronqvist and Stephan Siegel explain it this way:
“We find that a long list of investment biases (e.g., the reluctance to realize losses,5 performance chasing,6 and the home bias7) are human, in the sense that we are born with them. Genetic factors explain up to 45% of these variation in those biases across individuals. We find no evidence that education is a significant moderator of genetic investment behavior.”
Wow! It’s no wonder that the majority of investors succumb to short-term volatility in the market by selling and waiting until markets have been very strong to begin buying, even though more than 30 years of studies have proven this is exactly the wrong thing to do. It’s literally programmed into our genes and is impervious to education. We are also prone to a slew of cogitative biases, from overconfidence in our own abilities8 to our tendency to overweight things simply based upon how easily they are recalled.9 And knowing about our biases of judgment — something that has been noted in market research for more than 30 years — hardly eliminates them.
Successful Active investing runs contrary to human nature. It’s encoded in our genes to overweight short-term events, to let emotions dictate decisions and to approach investing with no underlying cohesiveness or consistency. Successful Active investors do not comply with nature; they defy it. The past, present, and future make up the now for them. It’s not natural to remain unmoved when watching others get caught up in spirals of greed and fear, causing booms and panics. It’s not natural to remain unemotional when short-term chaos threatens your nest egg. And, leading to my next required trait (“Valuing Process over Outcome”), it’s not natural to persevere in a rigorous, consistent manner — no matter what the market is doing.
Go to Part 2…
- Usually this happens at the least optimal time! When it happens at or near the market bottom, the investor basically “locks in” their losses.
- Can investors measure performance over periods as short as 3 years? In hindsight, look at how misleading even a 5-year period can be. Between 1/1/1964 and 12/31/1968, $10K invested in Portfolio A (annually buying the 50 stocks in the Compustat database with the best annual growth in sales) soared to $33.5K in value, a compound return of 27.3% per year — more than double the S&P 500 (10.2% annual return, $10K only grew to $16K). Unfortunately, the Portfolio A strategy didn’t fare so well over the next 5 years. Between 1/1/1969 and 12/31/1973, it lost more than half its value (losing 15.7% per year) versus a gain of 2% for the S&P 500. Think of the hapless investor who watched these types of stocks soar in value for the 5 years ending 12/31/1968. By doing what they considered “homework” — that is, reading all the glowing reports in the press about the impressive returns generated by the “gunslingers” on Wall Street — and not taking the plunge until 1969, their $10K would’ve dwindled down to just $4K. Yep, so much for only paying attention to a 5-year record.
- See Josh Brown’s TheReformedBroker.com/2014/08/07/fired-managers-outperform-hired-managers
- Tweet from Cliff Asness, Co-Founder AQR Capital Management. In reply to query the next day (“Any advice on how to do this successfully?”), Mr. Asness offers this sage advice: “Get yourself bitten by a radioactive Buffett or Bogle.”
- See wikipedia.org/wiki/Loss_Aversion
- See pressroom.vanguard.com/nonindexed/Quantifying_the_Impact_of_Chasing_Fund_Performance_July_2014.pdf
- See “Portfolio Patriotism, and Why You Should Avoid It” 5/3/14 (investorfieldguide.com)
- See wikipedia.org/wiki/Overconfidence_Effect
- See wikipedia.org/wiki/Availability_Heuristic