Sunday, November 24, 2013

9 Tips for Becoming a More Patient Investor

Even though the tag-line of the Clear Eyes Investing blog is, "Patience is the individual investor's greatest advantage over the market," patience is a virtue that doesn’t come naturally to me.

Maybe I played too much Nintendo as a kid or something, but my default expectation is for instant results. Whenever I’m stuck in highway traffic or waiting for a commuter train that’s running behind schedule on a frigid Chicago morning, I have to remind myself to stay calm and not get stressed, for it’s in such times that I’m prone to make stupid decisions.

Thankfully, I’m not alone in this. As Michael Mauboussin has noted in various articles, when we’re stressed, our mental time horizon shrinks and we have a tendency to make decisions that are completely focused on short-term results and we disregard long-term effects. Our brain’s reaction to stress may serve us well at times of imminent physical danger, but it can be really destructive when it comes to our financial health.

By reducing our investing stress and increasing our investing patience, I believe we can truly improve our long-term results. Indeed, hedge fund manager Joel Greenblatt recently said as much in a Morningstar interview:
"The secret to value investing is patience, and that's generally in short supply now...The world is becoming more institutionalized, there is more access to performance information, it's much easier to trade. So, patience is in short supply, and it really makes it much nicer for patient value investors…(Value investing) works over time, and it's quite irregular. But it does still work like clockwork; your clock has to be really slow." (My emphasis)
What are some ways that we can improve our ability to be patient? I’ve started a list here, but would also enjoy hearing your tips in the comments section below (or let me know on Twitter).

  1. Make a list of things that stress you out when investing: Knowing exactly what your stress triggers are will help you recognize them as they occur. One of my triggers, for example, is when a company I own makes a large acquisition that has a good chance of being value destructive. My instinct is to sell first and ask questions later, but the opposite has proven to be the better approach.
  2. Buy right and sit tight: Loss aversion is a powerful force -- and humans tend to feel the pain of a loss twice as much as the joy from a gain. In fact, some people are more sensitive to losses than others. As such, much of the investing stress that I’ve experienced myself and have heard from others comes on the selling end of an investment. Not knowing the right time to sell -- even if it will produce a gain -- can indeed be stressful. Howard Marks shared in his book, The Most Important Thing that Oaktree Capital employs the philosophy that "Well bought is half sold.” In other words, if you pay good prices for your investments, the selling should take care of itself (and be a lot less stressful).
  3. Have a 24-hour trading rule: If you’re feeling strong emotions before placing a trade -- excitement, agony, stress, etc. -- having a 24-hour trading rule can help you make calmer, more rational decisions. Take the time to consider why exactly you want to buy or sell this particular stock. You may still end up placing the trade the next day, but it will be done with more thought and less emotion.
  4. Establish longer-term performance benchmarks: Short-term investment performance has much more to do with luck than skill; therefore, it seems much more appropriate to judge our investments over a 3-5 year period rather than by a month or quarter. Granted, an investment thesis could completely fall apart within a year and action may be warranted, but aiming to give each investment a few years to play out before we sell it should reduce the need to impatiently sell based on short-term performance.
  5. Take stock quotes off your smartphone or internet homepage: There was a time not too long ago where you had to either call your (expensive) broker or wait for the daily newspaper to get the latest quote on your stock. With real-time quotes at our fingertips these days, I'd bet that those flashing green and red lights cause us to make more frequent trading decisions that we would otherwise. If you’re finding this to be the case in your own portfolio, try going without real-time quotes for a while and see if that helps.
  6. Stay diversified (to a point): Some investors will say that in order to really trounce the market, you need to have a very concentrated portfolio of just a few holdings that you really believe in. Perhaps there’s some truth to that, but there’s also something to be said for being able to sleep at night. As confident as I might be in a thesis, I also know that I’m fallible, so as a rule I don’t invest more than 10% of my portfolio in a single name. Having such a big bet on a single company would likely cause me to be impatient if my thesis wasn’t working out and make hasty trades.
  7. Read and re-read the classics: Regardless of how the market is behaving at a given time, remember that it’s happened before. The circumstances may be different, but investor behavior is the same. When in doubt about the current state of the markets, consult The Intelligent Investor, the annual Berkshire Hathaway letters, and just about any book on this list really. During the financial crisis, for example, Jack Bogle’s reflections on Wellington Fund’s 75th birthday helped me maintain my long-term approach during a very difficult time in the market.
  8. Find a “support” group: Most of the financial content on the internet is designed for short-term traders, but there are plenty of patient, long-term investors out there on various blogs (see a list of good blogs on the right), message boards, and websites that would be happy to help you work through an investment decision if you’re having trouble or have a question. Including this one!
  9. Start an investment journal: One of the best tips I received was to start an investment journal in which I wrote down my investment thesis, risks, and any emotions or concerns I felt when placing the order. This will serve to reduce “thesis drift” and help you make more rational decisions when you’re not sure what to do about a certain investment.